Ljuspunkten i börsmörkret: Trender

Almost everything is down this year. A rare bright spot? A backwater called trend following.

It’s easy to spot the trend followers at back-to-school time: Just look for the kids wearing the coolest sneakers. It’s easy to spot them in the markets these days, too. Look for fund managers with returns that are so hot they make most other types of investors look as if they’re sporting a pair of worn-out Keds.

It’s been a banner year for financial trend followers: It’s a style of investing dedicated to what the markets are actually doing, rather than what some expert thinks they should do. The benchmark gauge, Societe Generale SA’s SG Trend Index, is up 27% so far in 2022, poised for its best year in data since the start of this century.

That type of performance is hard to stomach for investors who focus on fundamentals. Traditionalists like to preach the virtues of deep-dive research or buying and holding a diversified portfolio. This is not that; these strategies trade frequently in an attempt to catch highs and lows.

Yet there’s no mistaking that trend following is working—spectacularly—when almost nothing else is. Stocks and fixed income markets are mired in simultaneous bear markets, wreaking havoc on traditional strategies including what’s known as 60/40, a balanced portfolio that invests 60% in stocks and 40% in Treasuries or other safe bonds. And the economic outlook hasn’t gotten any friendlier to that strategy, given the red-hot global inflation and central banks hellbent on taming it.

This new environment for investors, in which bonds can’t be trusted in their traditional role of protecting portfolios in turbulent times for stocks, has triggered a heated debate on Wall Street about building a more safe and reliable vehicle than 60/40. Everything including commodities and cryptocurrencies has been offered up as a possible contender for inclusion in that 40% bucket.

So is trend following worthy of consideration, even for the most traditional and cautious of investors? Well, let’s just say that if crypto has entered the chat, pretty much everything is on the table.

The trend-following strategy has been around for decades, used most notably by hedge funds trading in futures markets and often using borrowed money, or leverage, to amplify returns. It’s the dominant strategy for what are known as commodity trading advisers or managed futures funds. The implicit dual mandate of managed futures—says Cliff Asness, a longtime advocate of trend following who’s the co-founder and chief investment officer at AQR Capital Management LLC—is to “deliver positive returns on average” and “generate especially attractive returns during large equity market drawdowns.” That sounds an awful lot like the role bonds used to play in a balanced portfolio.

The most simple explanation of trend following is pretty easy to follow: Just buy the assets that have been going up recently and sell short those that have been going down. Implementation is more complicated. Market wizards known as quants deploy computerized black boxes filled with math to determine when trends have started or finished.

The trends in a variety of markets have been especially well-defined and long-lasting this year, with both stocks and bonds suffering meltdowns, oil and other commodities surging for much of the year, and the US dollar leaving most other currencies in the dust.

Of course, playing in the futures markets requires deep pockets. A single US Treasury note futures contract currently sells for about $115,000. An E-mini S&P 500 futures contract will set you back about $198,000, and one oil futures contract—which represents 1,000 barrels of crude—is about $87,000.

But since the last time managed futures funds proved their mettle in a bear market for stocks—the SG Trend Index was up 21% in 2008—several exchange-traded funds and mutual funds have emerged to offer mere mortals access to a version of the hedge fund party. Take the AlphaSimplex Managed Futures Strategy Fund, a mutual fund that’s up 38% in 2022 thanks in large part to following the trend lower in Treasuries and the trend higher in energy futures, among other trades.

“We do well when things are uncomfortable,” Kathryn Kaminski, chief research strategist at AlphaSimplex Group LLC and co-manager of the managed futures fund, told me on a recent episode of Bloomberg’s What Goes Up podcast. Betting on losses in Treasuries and the higher interest rates that accompany their price declines, for example, makes many investors uncomfortable because of that asset class’s long-term reputation as a haven in times of turbulence. “If I ask a group of people, ‘How many of you think that rates are going to go up?’ they’ll all raise their hands. But if you ask them, ‘How many of you are willing to short bonds or have shorted bonds?’ nobody does.” That highlights how most people are used to the idea of going long bonds, she says, whereas AlphaSimplex can take advantage of opportunities in the short run, even when they’re uncomfortable from an historical perspective.

The surprisingly weak performance of the Japanese yen vs. the dollar this year is another example of a trend that likely made fundamental investors uncomfortable, but it’s been highly lucrative for trend followers, says Andrew Beer, who co-manages the iM DBi Managed Futures Strategy ETF from Dynamic Beta Investments LLC. Betting on weakness in the Japanese currency was one of the most important trades that’s helped power a 27% gain for that ETF so far in 2022. The currency trades for more than 140 yen per dollar, having weakened from 115 at the start of the year.

“When you talk about the craziest things in the market,” Beer say, “I think if you’d asked FX strategists earlier this year, ‘The yen is at 115—where could it possibly go?’ the guy who said 125 would’ve been laughed out of the room.” And then lo and behold, he adds, the currency went on to get even weaker than that.

Regular investors appear to have taken notice of trend followers’ status as the go-to place for positive returns during a rough year for both stocks and bonds. For example, the Dynamic Beta fund, whose ticker is DBMF, has seen inflows for 18 straight months—helping its total assets jump more than 2,100%, from less than $31 million to $680.7 million. Smaller ETFs such as the Simplify Managed Futures Strategy ETF, the WisdomTree Managed Futures Strategy Fund, and First Trust Managed Futures Strategy Fund have also seen their assets grow.

Of course, it’s reasonable for traditional buy-and-hold investors to be skeptical that trend following is more than a flash in the pan, especially given it’s meh performance in the decade between the global financial crisis and the Covid-19 pandemic. If you cherry-pick a starting date for the comparison at the end of the financial crisis bear market in 2009, the S&P 500 has returned almost 700% while the SG Trend Index is up about 64%.

Yet the boilerplate on Wall Street that “past performance does not guarantee future results” is ubiquitous for a reason. And it’s starting to look as if this global market environment could produce results that are drastically different from the market performance in the decade preceding the Covid era, a period that was famous for containing the longest bull market in stocks.

So it’s worth considering whether this year’s standout performance in trend following could be the start of, well, a trend.

More stories like this are available on bloomberg.com.