Why You Should Expect Some Underperformance

Investment managers that employ trend-following strategies have had a challenging few years. Though not as significant as the underperformance realized by the value factor (relative to the growth factor), the last eighteen months of sideways, volatile price action in global equity markets has some pioneers of trend-following strategies questioning whether the strategy is still viable. They worry that low barriers to entry in regards to implementing a simple trend-following strategy have led to overcrowding, and thus have diminished the return profile of a once lucrative strategy. The recent string of underwhelming performance has led many hedge fund titans cutting back on their allocations to trend following-strategies.

However, not everyone believes the strategy is dead. Given that the existence of trend-following is tied to human biases, it might be too early to assume that humans have evolved enough to overcome their inherent biases. We would highlight that if strategies didn’t go through periods of underperformance, the theoretical expectation of excess return should be effectively zero. The hallmark of investment management is dealing with uncertainty, and in this case the only thing that is certain is that it is too early to tell whether trend-following is in the process of dying, or whether it’s just going through a period of range bound underperformance.