Meb Faber Asks: Why Aren't More Investor's Allocated to Trend Following?

February 7, 2023 rcm-alternatives 0 comment 2 Likes

Trend Following and Systematic Strategies

Amidst all the new year wishes, new year resolutions, and just normal new year meaning new work – you may have missed Meb Faber’s weekend post at the end of January. You may be wondering why so few investors have an allocation to trend following:

Astonishing to me that the vast majority of investors have zero trend following allocation.

“But Meb, there’s just not any managers with a long history…”

Here’s DUNN back to 1985…printed +60% in 2022!

via @rcmAlts database pic.twitter.com/1HUs8qfIcj

— Meb Faber (@MebFaber) January 21, 2023

Now, we’ll quickly add a past performance is not necessarily indicative of future results disclaimer to that tweet for Meb…and indeed, you’ll see that when accessing our database, but we think Meb’s point is less about last year’s performance (nearly everyone did well in trend) and more about how this is just the latest proof, in more than 40 years worth of history, of why investors should have trend in their portfolio.

His point…you SHOULDN’T think it’s too new or the track records are too short. There are decades of history of trend following. For history buffs, read our ‘History of Managed Futures’ whitepaper here. And his point…you SHOULD have an allocation to trend following. See our Guide to Trend Following whitepaper HERE for just what that allocation could and should look like.

But the real treat was in the tweets’ replies, where all sorts of implicit and explicit biases reared their heads to show just how misunderstood trend following is. Here are some of our favorites and our answers/comments/rebuttals =

We’ll start with some easy ones =

1. Are we sure this includes fees?

Yes, all Commodity Trading Advisors and/or Commodity Pool Operators registered with the National Futures Association – are required by law to show the performance NET of all fees, meaning any such submissions to databases such as the one here at RCM are showing the performance NET of fees, meaning the performance includes all fees, is after the effect of fees. Here’s the relevant Commodity Futures Trading Commission (CFTC) regulation if you’re into the Federal Register = CFTC Regulation 4.35(a)(6)(i)(D)

2. …what are the usual fees and minimum commitment for these types of funds?

Managed Futures and Trend Following funds and investment programs have been no stranger to the compression in fees over the past decade, but you can expect them all to charge an annual management fee of between 0.50% and 2% and an incentive fee of between 10% and 25%. The average these days is probably in the 1% and 17.5% range. The incentive fee is nearly always on new net profits, meaning there is a high watermark, and it is only charged after all other fees and expenses are realized. A high water mark means they have to get back above where fees were taken out previously in order to earn another incentive fee. As for minimum investment amounts, we’re talking $50,000 to $250,000 for investments into private funds running these models and $500,000 to $50,000,000 for separately managed accounts. And if commitment in that question meant how long…well not long at all. Most funds are monthly liquidity, and managed account investments are liquid within a day, with the investments all in exchange-traded futures in the client’s own account.

3. How would you define a “trend following allocation”?

A trend following allocation would simply mean an investor has some portion of their overall assets invested in trend following programs or funds. A 60/40 stocks/bonds portfolio has zero allocated to trend following. A framework like what Meb uses in some of his work, Standpoint’s 50/50 stocks/trend, the Cockroach Fund’s 50/50/50/50/20 – stocks/bods/trend/vol/gold, or return stacking’s model have significant allocations to trend.

Then some more sophisticated ones =

4. …but not all managed futures/trend did well. For example, FORT is highly regarded and got creamed. Within the asset class the variance in performance is high.”

This one seems to always be a big source of confusion for investors despite our best efforts to dispel it…equating ‘managed futures’ with ‘trend following.’ See RCM partner Jeff Malec’s excellent tweet thread on this here, where he summarizes it as:

Managed Futures = the Asset Class/Allocator bucket

CTAs = the technical name / registration status

Trend Followers = the predominant strategy

So, saying that not all trends did well because FORT did poorly is off the mark. FORT is in the managed futures bucket, and FORT is a CTA. But FORT is not a trend follower. There are strategies as diverse as option selling discretionary energy trading, and ultra-short-term automated trading, all under the managed futures umbrella. And that is what causes the big variance in performance between different programs. But if you dig deeper and compare trend with trend, or energy with energy, for example – there is less dispersion as you would expect from funds and managers trading similar strategies and markets. Generally speaking, the sign will be the same on most managers in a specific strategy bucket, like trend following, with differences in volatility and whether they skew more financials or commodities.

5. I’ll bet none of these will work in taxable accounts, most of the alpha goes to them in fees and only qualified or accredited investors could invest in them. There’s a reason these things are not well-known or used.

Again, this is all net of fees. So any alpha you see on the page is alpha the investors are receiving. This is mostly correct on the need to be qualified or accredited, with most programs and funds choosing to go that route to save on the effort and cost of compliance. However, there’s a growing list of mutual fund products, like Standpoint and Resolve mentioned above, blending trend following approaches with other alpha and beta sources available to non-accredited investors in taxable accounts.

And speaking of ‘taxable’, it’s worth noting here that trend following and managed futures mutual funds get the special 60% long-term capital gains and 40% short-term capital gains treatment passed through to the end investor.

6. Volatility seems high. How would performance compare to the S&P 500 levered to the same volatility?

“Seems… “is the key here. It turns out, you don’t have to do too much work to compare performance to the S&P 500 levered to the same volatility. Since 2000, the Soc Gen Trend Index has an annualized volatility of 13.6% versus the S&P, clocking in at a vol of 15.5%. That’s right, the trend index is actually less volatile than everyone’s favorite traditional investment, the stock index. What’s more, most trend programs can and do target a specific volatility level (usually 10% to 17.5%), whereas you never know what you’re going to get in the volatility department with stocks.

So while we’re not sure this commenter wanted to see Trend levered up to match stock volatility, here’s what that looks like since 2000:

Past performance is not necessarily indicative of future results.