The Convexity of Trend Following

Protecting your assets but perhaps not as much as you would like!

Capital Fund Management (CFM) LLP
Originally published in the May 2018 issue

Executive summary

Much has been made recently of crisis alpha or crisis risk offset. And, in particular, of using trend following as a hedge of future downside moves in, mostly, equity markets. We demonstrate that trend following is mechanically convex relative to the underlying upon which one is trending, but, that the overall convexity offered by CTAs is mitigated by implementation steps that improve risk and execution cost adjusted returns. Trend Following should primarily be viewed as a highly statistically significant strategy, while the existence of convexity, albeit weak, should be considered a bonus feature to an investment in Trend Following.


Commodity Trading Advisors (CTAs) have traded futures markets for many years using, on aggregate, an approach exploiting the persistence of trends in prices. It has been demonstrated by many, the current authors included, that following trends is a profitable strategy with a high level of statistical significance. The Sharpe ratios observed by a systematic approach are modest, as are the returns of the industry. These modest Sharpe ratios are, however, persistent – leading to the conclusion that the approach represents one of a growing number of alternative benchmark strategies upon which the alternative beta industry has been created.

However, traditional benchmarks still reign supreme, with equity indices composed of developed markets and/or emerging markets mixed in with both sovereign and corporate fixed income type return streams representing the backbone of most institutional investment portfolios. These investments are sound, with expected Sharpe ratios in the range of 0.3-0.4 for equities and, to first order, the excess yield of developed market sovereign bonds leading to low Sharpe ratios in low interest rate regimes. The advent of the Alternative Beta industry has spurned interest in an alternative, decorrelated (and hopefully positive) return stream that can potentially help to decrease the volatility and drawdowns of investor portfolios.

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