From past experience, central bank interest-rate-setting committees tend to demonstrate inertia in the face of regime changes. Similarly, investors demonstrate inertia because it is difficult to tell whether a regime change actually has occurred. This is a perfect environment for a hedge fund strategy like trend following to do well. Trend following does best when it’s exploiting inertia. And if trend following does well, then systematic macro and discretionary macro, which are country cousins of trend following, are also going to do well.
There is a well above-average probability of a recession in the U.S. and the U.K. in the next two years, and that represents a significant discontinuity in economic behavior. Trend followers are great at exploiting such breaches. The combination of regime change and recession risk should make strategies like trend following, systematic macro and discretionary macro attractive.
Ironically, the biggest threat to trend following would be a drastic improvement in the macro environment. If supply constraints ease, inflation suddenly starts declining and markets settle down, then the trend-following positions that have prospered this year may suddenly reverse. At that point, the challenge will be discerning if what we are seeing today is a bull market correction or a secular change. This scenario is one that would benefit those who combine trend following with other investment styles within a single fund. Even in portable alpha solutions, diversification can be helpful.
Sushil Wadhwani is CIO at PGIM Wadhwani, a quantitative multiasset macro specialist, backed by PGIM. He is based in London. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I’s editorial team.