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    Top Traders Unplugged

    SI284: Choosing Your Trend Following Battles ft. Nick Baltas

    Sat Feb 24 2024
    systematic investingreliable strategiesfactor regressionmanaged futuresCTA industrytrend following strugglesoptimal portfolio designfactor timingportfolio timinginvesting in trend followingalternative marketsdefining liquidity

    Description

    The episode covers systematic investing, reliable strategies, factor regression, managed futures, decline in the CTA industry, trend following struggles, optimal portfolio design, factor timing, effective portfolio timing, investing in trend following and alternative markets, expanding into alternative markets, and defining liquidity in trend following.

    Insights

    Trend following as an independent strategy

    The transcript highlights the challenges of predicting future market trends and the importance of trend following as an independent strategy based solely on price movements.

    Optimal portfolio design for trend following

    The paper introduces a model that considers assets exhibiting trends and aims to optimize portfolio design based on this model. Backtesting over 23 years suggests that the agnostic risk parity and trend-following risk parity portfolios perform well when diversified across principal components.

    Timing strategies in volatile markets

    Timing strategies in volatile markets requires high skill due to unpredictable down moves. Frequency of trading is crucial, with daily trading potentially leading to significant gains but also increased risks due to scaling down.

    Investing in alternative markets

    Investors often consider adding alternative markets to their portfolios, but long-term returns do not consistently support the notion that these markets outperform traditional ones. The risk of investing in certain countries for alternative exposure should be carefully considered.

    Expanding into alternative markets

    Expanding into alternative markets should be a consideration between marginal gain versus cost. Alternative commodity markets may have value in trend following portfolios due to sustained trends driven by fundamental reasons like supply constraints.

    Chapters

    1. Systematic Investing and Reliable Strategies
    2. Factor Regression and Managed Futures
    3. Decline in CTA Industry and Trend Following Struggles
    4. Performance of Trend Following Strategies
    5. Optimal Portfolio Design for Trend Following
    6. Factor Timing and Strategy Selection
    7. Effective Portfolio Timing
    8. Investing in Trend Following and Alternative Markets
    9. Expanding into Alternative Markets
    10. Defining Liquidity and Trend Following
    Summary
    Transcript

    Systematic Investing and Reliable Strategies

    00:01 - 07:32

    • The podcast discusses systematic investing and a reliable yet often overlooked investment strategy.
    • The hosts talk about the recent performance of non-trend components in the market and the uncertainty surrounding equity markets hitting all-time highs.
    • They mention the Nikai 225 index breaking its long-term record after a 35-year drawdown, which is significant for Japanese investors.
    • A discussion on defensive solutions and drawdowns in systematic strategies is highlighted, including an anecdote about preparing a report on this topic.
    • From a trend-following perspective, there are strong trends across various markets and sectors in February, with notable performances in equities, soft commodities, grains, and natural gas costs.

    Factor Regression and Managed Futures

    07:02 - 14:40

    • Financial market updates: S&P 500 Total Return Index up 5% in February and almost 7% for the year, MSCI World Index up about 4% last night and 5% for the year.
    • Discussion on using factor regression to evaluate managed futures with a focus on a seven-factor model developed by academics in the early 2000s to explain trend followers' performance.
    • Debate on whether factor models are effective in attributing performance or identifying risks in portfolios, with considerations on the complexity of these models compared to trend-following strategies.
    • Importance of having a risk model for manager selection and potential value of linear regression models in identifying different CTAs with similar profiles.

    Decline in CTA Industry and Trend Following Struggles

    14:20 - 21:41

    • The podcast discusses a decline in the number of participants in the CTA industry, with a 30% annual decline in the number of CTAs.
    • There has been an overall decline in the number of participants across different categories within the industry, except for brokers (FCMs) which saw a small increase.
    • The total number of registered CTAs has significantly dropped from around 1360-1370 to around 1250, and commodity pool operators have also decreased from around 1260 to around 1200.
    • Another topic covered is an article on trend following struggles to return to popularity, focusing on how trend following fits into institutional portfolios amidst market uncertainties.

    Performance of Trend Following Strategies

    21:21 - 28:42

    • The podcast discusses the performance of trend following strategies in volatile market environments, with mixed opinions on its effectiveness.
    • There is a debate on how to interpret the performance of trend following strategies in 2023 compared to the strong performance in 2022.
    • The transcript highlights the challenges of predicting future market trends and the importance of trend following as an independent strategy based solely on price movements.
    • A paper titled 'Optimal Trend Following Portfolios' by Sebastian Valerie is mentioned, focusing on theoretical aspects and optimal portfolio construction based on trend following signals.

    Optimal Portfolio Design for Trend Following

    28:24 - 36:08

    • The paper discusses the concept of trend following in portfolios and its theoretical implications.
    • It introduces a model that considers assets exhibiting trends and aims to optimize portfolio design based on this model.
    • The model incorporates factors like drift, stochastic trends, serial correlation, momentum, and cross correlations between markets.
    • Four different portfolios are proposed based on various assumptions and strategies: min variance with drifts, mean variance using trends, agnostic risk parity across principal components, and trend-following risk parity.
    • Backtesting over 23 years suggests that the agnostic risk parity and trend-following risk parity portfolios perform well when diversified across principal components.

    Factor Timing and Strategy Selection

    35:57 - 42:55

    • The podcast discusses a paper on factor timing and challenges in the market, focusing on the importance of timing and strategy selection.
    • The paper emphasizes the significance of perfect foresight in timing strategies and how it impacts expected returns.
    • It highlights that the higher the Sharpe ratio of a strategy, the lower the incremental value brought by timing, stressing the need to benchmark one's skill against the strategy itself.
    • Frequency of trading is crucial, with daily trading potentially leading to significant gains but also increased risks due to scaling down.

    Effective Portfolio Timing

    42:31 - 49:31

    • Pick your fights and trading frequency based on trading costs.
    • Skill level required to outperform varies with strategy performance and frequency of trading.
    • Timing strategies in volatile markets requires high skill due to unpredictable down moves.
    • Portfolio timing involves overweighting high-value strategies while considering diversification and correlation levels.
    • Timing a portfolio effectively requires moderate correlations and diversification for impactful active weights.

    Investing in Trend Following and Alternative Markets

    49:12 - 56:43

    • Timing investments in trend following is challenging due to the difficulty of predicting market movements across different asset classes.
    • Investors often consider adding alternative markets to their portfolios, but long-term returns do not consistently support the notion that these markets outperform traditional ones.
    • The risk of investing in certain countries for alternative exposure should be carefully considered, as regulatory crackdowns and operational difficulties may impact performance.

    Expanding into Alternative Markets

    56:18 - 1:03:30

    • Expanding into alternative markets should be a consideration between marginal gain versus cost.
    • Alternative commodity markets may have value in trend following portfolios due to sustained trends driven by fundamental reasons like supply constraints.
    • Different trend followers may choose structurally different managers trading varying numbers of markets and employing diverse risk management strategies.
    • Commodities, seen as alternative markets, offer both risks and rewards for trend followers with significant performance variations.
    • Past returns at the strategy level do not statistically predict future returns, emphasizing the need to analyze market structures and reasons behind trends for investment decisions.

    Defining Liquidity and Trend Following

    1:03:03 - 1:06:34

    • There is a difference in defining liquidity between trading managers and building indices.
    • Trend following allows capturing strong trends in different sectors like bonds, equities, and commodities.
    • Playing in a larger sandbox than traditional portfolios leads to delivering different return streams.
    • The host appreciates the guest's time and encourages listeners to rate and review the podcast.
    • Upcoming episodes will feature discussions on volatility and global macro space.
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