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Trend Following with Managed Futures: The Search for Crisis Alpha



“WOW!! Everything you ever wanted to know about trend following over the past 800 years, from the theoretical to the practical, can be found in this book. If you are contemplating an allocation to or redemption from CTAs, you should read this book first.”
—Ed Robertiello, CFA, Senior Portfolio Manager, Absolute Return Strategies, CalPERS

“Alex Greyserman and Kathryn Kaminski have provided a full insight into trend following models in simple language and with examples throughout this book. They have demystified the black box notion associated with managed futures/trend followers.”
—Romule Nohasiarisoa, CFA, Senior Hedge Fund Analyst, PGGM Pension Fund, Netherlands

“Alex and Kathryn are prolific researchers in the world of managed futures and manager selection. This work is a significant contribution to the understanding of CTA performance and is a must read for anyone interested in analyzing CTA returns.”
—Adam Duncan, Senior Investment Director, Cambridge Associates

“This book is a fascinating and timely examination of an investment strategy that, for too long, has dwelt in the shadows of the financial industry. Every serious investor should read this book!”
—Andrew Lo, PhD, Charles E. and Susan T. Harris Professor of Finance, MIT Sloan School of Management

“This is a must have on the bookshelf of any institutional investor. Alex and Kathryn bring academic rigor to CTA investing in an easily digestible and understandable framework.”
—Lawrence Kissko, Head of Macro and Quantitative Strategies, Hermes BPK Partners

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 Andrew W Lo xi

Preface xv

Introduction xxi


CHAPTER 1 A Multicentennial View of Trend Following 3

The Tale of Trend Following: A Historical Study 5

Return Characteristics over the Centuries 8

Risk Characteristics over the Centuries 17

Portfolio Benefi ts over the Centuries 19

Summary 21

Appendix: Included Markets and Relevant Assumptions 21

Further Reading and References 23


CHAPTER 2 Review of Futures Markets and Futures Trading 27

Forward and Futures Contract Fundamentals 27

Review of the Managed Futures Industry 34

Futurization 38

Summary 43

Further Reading and References 43

CHAPTER 3 Systematic Trend Following Basics 45

The Basic Building Blocks of a Trend Following System 47

Strategy Classifi cation and Core Diff erentiators 56

Partitioning Trend Following Systems 60

Summary 61

Further Reading and References 61


CHAPTER 4 Adaptive Markets and Trend Following 65

The Adaptive Market Hypothesis 66

A Framework for Speculative Risk Taking 75

A Closer Look at Crisis Alpha 78

Summary 91

Further Readings and References 91

CHAPTER 5 Divergence and the Tradability of Trend 93

Risk versus Uncertainty 93

Convergence versus Divergence 95

Measuring Market Divergence at the Portfolio Level 106

Testing the Stationarity of Market Divergence 114

The Tradability of Trend 117

The Importance of Entry versus Exit 121

Summary 124

Further Reading and References 124

CHAPTER 6 The Role of Interest Rates and the Roll Yield 127

Collateral Yield 128

Decomposition into Roll Yield and Spot 131

Summary 138

Further Reading and References 139


CHAPTER 7 Properties of Trend Following Returns 143

Trend Following as an Alternative Asset Class 143

Crisis Alpha 145

Crisis Beta 149

Key Statistical Properties 155

Summary 159

Appendix: A Summary of Common Performance Measures 160

Further Reading and References 161

CHAPTER 8 Characteristics of Drawdowns, Volatility, and Correlation 163

Understanding the Properties of Drawdowns 163

Volatility of a Trend Following Portfolio 173

Correlation and Diversification at the Portfolio Level 181

Summary 185

Further Reading and References 186

CHAPTER 9 The Hidden and Unhidden Risks of Trend Following 187

Directional and Nondirectional Strategies: A Review 187

Defining Hidden and Unhidden Risks 188

The Myths and Mystique of the Sharpe Ratio 195

Unraveling Hidden Risks of Dynamic Leveraging 196

Summary 207

Further Reading and References 207

CHAPTER 10 Trend Following in Various Macroeconomic Environments 209

Interest Rate Environments 210

Regulatory Forces and Government Intervention 217

Postcrisis Recovery 221

Summary 228

Further Reading and References 229


CHAPTER 11 Return Dispersion 233

Strategy Classification and Return Dispersion 234

A Closer Look at Capital Allocation and Position Sizing 239

Return Dispersion from an Investor’s Perspective 247

Empirical and Theoretical Considerations for Correlated Return Series 256

Summary 263

Further Reading and References 264

CHAPTER 12 Index and Style Factor Construction 265

Divergent Risk Taking Revisited 266

Defining a Divergent Trend Following Strategy 269

Constructing Style Factors 277

Characteristics of the Style Factors 282

Summary 286

Further Reading and References 287

CHAPTER 13 Benchmarking and Style Analysis 289

A Framework for Return-Based Style Analysis 290

Style Analysis for Individual CTA Managers 294

Sector Level Analysis of the Market Size Factor 299

Style Analysis Clarifications 304

Manager Selection and Allocation 310

Summary 313

Further Reading and References 313


CHAPTER 14 Portfolio Perspectives on Trend Following 317

A Closer Look at Crisis Alpha 317

The Impact of Mark-to-Market on Correlation 326

Understanding Volatility Cyclicality 329

Summary 334

Further Reading and References 335

CHAPTER 15 Practicalities of Size, Liquidity, and Capacity 337

Does Size Matter? 337

The Impact of Less Liquid Markets 345

Summary 351

Appendix: Market Symbols and Names 352

Further Reading and References 352

CHAPTER 16 Diversifying the Diversifier 353

From Pure Trend Following to Multistrategy 354

Portfolio Analysis of the Move to Multistrategy 358

Hidden Risk of Leveraging Low-Volatility Strategies 368

Summary 374

Further Reading and References 374

CHAPTER 17 Dynamic Allocation to Trend Following 375

A Framework for Dynamic Allocation 375

Mean Reversion in Trend Following Return Series 377

Investigating Dynamic Allocation Strategies 384

Summary 389

Appendix: A Theoretical Analysis of Mean Reversion in Trend Following 390

Further Reading and References 393

Glossary 395

About the Authors 407

Index 409