Trend Following with Managed Futures

ALEX GREYSERMAN, PHD, is Chief Scientist at ISAM and serves as Adjunct Professor in the Graduate Program in Mathematical Finance at Columbia University.KATHRYN M. KAMINSKI, PHD, is the Deputy Managing Director of the Institute for Financial Research (SIFR), external market commentator for the CME Group, and affiliated faculty at the Stockholm School of Economics.

• Foreword xiAndrew W. LoPreface xvIntroduction xxiPart I Historical PerspectivesChapter 1 A Multicentennial View of Trend Following 3The Tale of Trend Following: A Historical Study 5Return Characteristics over the Centuries 8Risk Characteristics over the Centuries 17Portfolio Benefits over the Centuries 19Summary 21Appendix: Included Markets and Relevant Assumptions 21Further Reading and References 23Part II Trend Following BasicsChapter 2 Review of Futures Markets and Futures Trading 27Forward and Futures Contract Fundamentals 27Review of the Managed Futures Industry 34Futurization 38Summary 43Further Reading and References 43Chapter 3 Systematic Trend Following Basics 45The Basic Building Blocks of a Trend Following System 47Strategy Classification and Core Differentiators 56Partitioning Trend Following Systems 60Summary 61Further Reading and References 61Part III Theoretical FoundationsChapter 4 Adaptive Markets and Trend Following 65The Adaptive Market Hypothesis 66A Framework for Speculative Risk Taking 75A Closer Look at Crisis Alpha 78Summary 91Further Readings and References 91Chapter 5 Divergence and the Tradability of Trend 93Risk versus Uncertainty 93Convergence versus Divergence 95Measuring Market Divergence at the Portfolio Level 106Testing the Stationarity of Market Divergence 114The Tradability of Trend 117The Importance of Entry versus Exit 121Summary 124Further Reading and References 124Chapter 6 The Role of Interest Rates and the Roll Yield 127Collateral Yield 128Decomposition into Roll Yield and Spot 131Summary 138Further Reading and References 139Part IV Trend Following as An Alternative Asset ClassChapter 7 Properties of Trend Following Returns 143Trend Following as an Alternative Asset Class 143Crisis Alpha 145Crisis Beta 149Key Statistical Properties 155Summary 159Appendix: A Summary of Common Performance Measures 160Further Reading and References 161Chapter 8 Characteristics of Drawdowns, Volatility, and Correlation 163Understanding the Properties of Drawdowns 163Volatility of a Trend Following Portfolio 173Correlation and Diversification at the Portfolio Level 181Summary 185Further Reading and References 186Chapter 9 The Hidden and Unhidden Risks of Trend Following 187Directional and Nondirectional Strategies: A Review 187Defining Hidden and Unhidden Risks 188The Myths and Mystique of the Sharpe Ratio 195Unraveling Hidden Risks of Dynamic Leveraging 196Summary 207Further Reading and References 207Chapter 10 Trend Following in Various Macroeconomic Environments 209Interest Rate Environments 210Regulatory Forces and Government Intervention 217Postcrisis Recovery 221Summary 228Further Reading and References 229Part V Benchmarking and Style AnalysisChapter 11 Return Dispersion 233Strategy Classification and Return Dispersion 234A Closer Look at Capital Allocation and Position Sizing 239Return Dispersion from an Investor’s Perspective 247Empirical and Theoretical Considerations for Correlated Return Series 256Summary 263Further Reading and References 264Chapter 12 Index and Style Factor Construction 265Divergent Risk Taking Revisited 266Defining a Divergent Trend Following Strategy 269Constructing Style Factors 277Characteristics of the Style Factors 282Summary 286Further Reading and References 287Chapter 13 Benchmarking and Style Analysis 289A Framework for Return-Based Style Analysis 290Style Analysis for Individual CTA Managers 294Sector Level Analysis of the Market Size Factor 299Style Analysis Clarifications 304Manager Selection and Allocation 310Summary 313Further Reading and References 313Part VI Trend Following in an Investment PortfolioChapter 14 Portfolio Perspectives on Trend Following 317A Closer Look at Crisis Alpha 317The Impact of Mark-to-Market on Correlation 326Understanding Volatility Cyclicality 329Summary 334Further Reading and References 335Chapter 15 Practicalities of Size, Liquidity, and Capacity 337Does Size Matter? 337The Impact of Less Liquid Markets 345Summary 351Appendix: Market Symbols and Names 352Further Reading and References 352Chapter 16 Diversifying the Diversifier 353From Pure Trend Following to Multistrategy 354Portfolio Analysis of the Move to Multistrategy 358Hidden Risk of Leveraging Low-Volatility Strategies 368Summary 374Further Reading and References 374Chapter 17 Dynamic Allocation to Trend Following 375A Framework for Dynamic Allocation 375Mean Reversion in Trend Following Return Series 377Investigating Dynamic Allocation Strategies 384Summary 389Appendix: A Theoretical Analysis of Mean Reversion in Trend Following 390Further Reading and References 393Glossary 395About the Authors 407Index 409

The authors have raised the standard for discussion concerning trend following. The hedge fund industry should take note, and all strategies should be given the same level of attention and detailed review. For investors who are contemplating a trend-following managed futures investment, this book should be the first place to go in getting up to speed.– CFA Institute