Trend Following Without Rates?
Trend Following Without Rates?
I'm not quite sure which forum to post this question in, but as some of you may have already considered this issue in designing a system, here's the basic question. I've read that "Rates" are responsible for a majority of the profits in trend following systems for the past 30 years or so (due mainly to the unrelenting and trending bull market in rates/bonds). I trust it's safe to say that this is over (not to say it will necessarily reverse) but rates can only go to zero. If you were going to design a simple trend following system that deemphasizes rates, how would you alter the system either in terms of risk, money management or choice of markets to trade while still aiming to maintain historical CAGR, Sortino, max drawdown etc. Or, do you just resign yourself to likely less profitable trading going forward without the huge tailwind of rates?
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- Roundtable Knight
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Re: Trend Following Without Rates?
Take a look at bond futures prices: 1) unadjusted and 2) back adjusted. Take a look at a bond index: 1) price only 2) with coupons reinvested. Take a look at a bond mutual fund: 1) price only and 2) with coupons reinvested.
This will tell you where bond returns come from when you operate a constant maturity scheme.
Ask yourself: where do bond returns come from given the operation of a constant maturity scheme?
Do bond returns come mostly from price movement? Do bond returns come mostly from coupon? If the former then investment in bonds is a disaster in an era of rising rates. If the latter then you may come to a different conclusion.
This will tell you where bond returns come from when you operate a constant maturity scheme.
Ask yourself: where do bond returns come from given the operation of a constant maturity scheme?
Do bond returns come mostly from price movement? Do bond returns come mostly from coupon? If the former then investment in bonds is a disaster in an era of rising rates. If the latter then you may come to a different conclusion.
Re: Trend Following Without Rates?
Even when you take the cash earned on collateral, the majority of the profits earned by TF following funds have been in capturing the price movements in rates so I'm not sure I see your point. Bond funds may be different in that they are eternally invested in bonds and as such reap all the income as well as the capital appreciation.
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- Roundtable Knight
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Re: Trend Following Without Rates?
The price of a futures contract is determined by the spot price of the underlying asset, adjusted for time plus benefits such as coupon and dividends.
Re: Trend Following Without Rates?
Good point there and the answer is very much dependent on the average time to maturity exposure of the fund. Zero coupon bonds having no income, just pure exposure to the leveraged price of the longest maturity dates, but to me the question remains as the answer to your question is it has varied greatly over the past 30 years but both sides have helped significantly.
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- Roundtable Knight
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Re: Trend Following Without Rates?
I don't know whether this might help your decision making?
Re: Trend Following Without Rates?
I've been hearing the same concern for several years now. A couple of observations/comments:
1) When I eliminate all fixed income futures from my portfolio, the simulated results do not change much. The annualized return drops by less than 1%. This is because in a world with no Bonds or STIRs, the other markets pick up the slack by accepting higher relative weightings. You lose diversification, no doubt; but it's hardly a death sentence.
2) The argument that trend following will be impacted by lower rates is different from the argument that trend following will be impacted by the end of the bull market in Bonds. The first argument implies that collateral yield has been a significant component of CTA returns, which is true, but only on a nominal return basis. Interest rates mostly track inflation, in real terms an 8% compounded return with deflation can increase true wealth far more than a 10% return with inflation. The second argument is pure nonsense in my opinion. If the end of a bull market in an asset class equates to the end of returns for trend following...then trend following dies every few years.
1) When I eliminate all fixed income futures from my portfolio, the simulated results do not change much. The annualized return drops by less than 1%. This is because in a world with no Bonds or STIRs, the other markets pick up the slack by accepting higher relative weightings. You lose diversification, no doubt; but it's hardly a death sentence.
2) The argument that trend following will be impacted by lower rates is different from the argument that trend following will be impacted by the end of the bull market in Bonds. The first argument implies that collateral yield has been a significant component of CTA returns, which is true, but only on a nominal return basis. Interest rates mostly track inflation, in real terms an 8% compounded return with deflation can increase true wealth far more than a 10% return with inflation. The second argument is pure nonsense in my opinion. If the end of a bull market in an asset class equates to the end of returns for trend following...then trend following dies every few years.
Re: Trend Following Without Rates?
have you recalculated your thoughts based on rates can only go to zero ? gven Euribor trades above 100 and U.S rates are probably on their way to minus 3 % ?