MARGIN CALL: The trend is your friend

In mid-January, the Wall Street Journal reported George Soros had lost nearly $US1 billion as a result of the sharemarket rally spurred by Donald Trump’s surprise election as president.

But Stanley Druckenmiller, Mr Soros’ former deputy who helped him score $US1 billion of profits betting against the UK pound in 1992, anticipated the market’s climb and racked up sizable gains.

These two contrasting outcomes illustrate the vagaries of hedge fund managers placing bets on events such as elections.

Though the market has seesawed in the past few weeks, earlier this week Wall Street was still holding above the 20,000 level on the Dow Jones Industrial Average.

Of course, most investors – or even fund managers – are not in Soros’ class and predicting the path ahead under the Trump administration is fraught with uncertainty.

Yes, that same uncertainty that this column reported just two weeks ago was not fazing consumers, who have boosted confidence around the world in the wake of Brexit, Europe’s immigration crisis, terrorist attacks and even Mr Trump himself.

Emerging markets have also enjoyed a strong run after all the expectations that a Trump victory would hit these places hardest.

So, as a change, I am focusing on an alternative investment strategy that forgoes prediction for technical analysis of price movements, known as trend following.

Gained acceptance
Though this has been around since the 1980s, it is only lately that it has come into its own as an investing tool that has gained acceptance in academic and financial circles.

Help in backgrounding this topic has come from Christopher Reeve, a London-based product development manager for Aspect Capital.

Aspect manages $US6.5 billion in funds after being launched 20 years ago. Its founders were pioneers in the mid-1980s of using technical analysis techniques to capture swings in the market.

Mr Reeve was in New Zealand to interest institutions and retail investors in a method he says over Aspect’s 20-year history has produced annualised returns of about 8%, much of that at times when – as during the global financial crisis – they offset heavy losses.

Mr Reeve starts his explanation with the observation that trend following is an intuitive concept to understand. Market prices move in swings and trends. Human herd behaviour or biases and economic cycles give rise to trends in markets.

“All we are trying to do is capture those moves,” Mr Reeves says. “Follow the trend, change your mind when it turns around changes – this works well over time.

“It has its ups and downs along the way because trends come to an end and you expect to see some giveback of that profit before you get out. That’s why you have have to do it in a disciplined, repeatable and systematic fashion.”

Evidence-driven
Those final few words refer to complicated algorithms and programs, usually of a proprietary nature, that Aspect uses and won’t be explained here.

“What we’re not trying to do is predict or guess and take a view on the market,” Mr Reeves says. 

“We are driven by the evidence. We’re not looking to predict when the trend will reverse but we react when it does. That’s what the models are designed to do. They look for the next new trend.”

If you are comforted by the knowledge that you can ignore the noise of political announcements and adverse news, then trend following looks good if done well.

Trend following is uncorrelated to investing in stocks, bond, commodities, Mr Reeve emphasises. 

“It produces its performance at different times and has its difficult periods at different times from traditional investing. That diversification, which is often seen as the only ‘free lunch’ in investing, is the most valuable service we can provide clients.

“As a strategy it often performs well just at the best times when other asset classes in a portfolio are struggling.”

It also means not giving into temptation. “Our trend-following strategy has a small edge and we don’t want to destroy that by intervening, sticking our foot on the brake and stopping our portfolio at what could be the best possible periods.

“As long as there are liquid markets being traded by humans whose behaviour will create trends in prices, we see that as potential opportunities for us.”