INSIGHTS

For the second season of Long Story Short, Trend Setters is demystifying the world of trend-following strategies and why they work in volatile markets. Russell Korgaonkar, CIO at Man AHL, joins the podcast to demystify why these strategies often work when others don’t.

Peter van Dooijeweert talks to Russell Korgaonkar, CIO at Man AHL, about why trend-following strategies work in inflationary and crisis environments. Listen to the first episode of Trend Setters, the new season of our podcast Long Story Short.

Recording date: August 2022

Episode Transcript

Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

Peter van Dooijeweert:

Hi, Russell. Thanks for joining us.

Russell Korgaonkar:

Thank you, Peter.

Peter van Dooijeweert:

So it’s been a pretty wild year in markets in 2022 and as CIO of AHL, you’ve had really a great vantage point to see a lot of it. Bonds and equities have done terribly. Energy commodities have soared. Other things like metals and Bitcoin have plunged. Somehow trend strategies have navigated all really, really well. They’ve posted strong returns and investors are definitely paying attention. But before we dig into the returns, I thought maybe we could start a bit more simply about how and why it works. And so maybe to start off, what exactly is a Trend-following strategy?

Russell Korgaonkar:

Sure. So a Trend-following strategy is at its very heart, very basics, one where we try to identify for prices moving upwards, or it’s moving downwards. If it’s moving upwards, we’ll take a long position. And if it’s moving downwards, we’ll take a short position. And basically that’s a nuts and bolts of a Trend-following strategy. Obviously all of the intricacy is in which markets, which ones do you trade, how big should your position be, how do you control your risk, et cetera. But right at its heart, it’s identifying if a market is moving upwards and if it is going long and vice versa.

Peter van Dooijeweert:

I see. And so how does that roll up into a fund that trades trend? It’s not purely S&P or bonds or what is it?

Russell Korgaonkar:

Nope. It’s not purely S&P, or bonds, or currencies, or any particular commodities. And one of the nice things about trend and one of the necessities about making Trend-following work is that it works in lots of different places. So in order for us to make a robust strategy, we need to apply Trend-following really in as many places as we can. So that’s the idea.

Peter van Dooijeweert:

So as you describe it, it all sounds pretty simple. So could an investor just fire up an Excel spreadsheet and do it by themselves?

Russell Korgaonkar:

At the heart, the concept of Trend-following is very straightforward. I explained it before. I make some identifier for prices going up and then take a long position and vice versa. So at it’s heart, it’s very straightforward. The nuance obviously, and the difference between running something basic and it not quite working and you getting frustrated and the returns not being as you would hope is how you construct your signal and manage your risk. So all of the details that go into building a portfolio and then crucially, how you execute. So you are trading a lot in the Trend-following strategy typically, and you need to manage that cost of execution. So could you do it in a spreadsheet? Yes, you possibly could. Would I? Probably not. Would I suggest you’d have a large chance of that working? I think it is a bit more tricky.

Peter van Dooijeweert:

It reminds me, I was a PM at a macro fund a long time ago, and PMs and macro funds tend to focus a little bit like on FX, or bonds, or commodities, something specific. But it’s pretty rare, a guy punts around in net gas and South African currency. But yet you guys do a lot of all of this. So how do you go about managing it? How do you control it all? How does this work?

Russell Korgaonkar:

The tricks of Trend-following or one of the things that it’s important to get right, is when you put all of these signals together and you run it across lots of different markets, you end up building risk exposures. So you’ll end up being long equity risk, or long the dollar, or short bonds, or whatever big macro exposure you tend to take. And you need to be a little bit careful that that exposure is reasonable, it’s within some sensible limits, because of course the flip side to Trend-following is the reversal bit, which happens from time to time. And our objective here is to make us as much profits as we can, subject to controlling the tail, and that is always the way that you need to think about constructing portfolios.

Peter van Dooijeweert:

I might take a step back then and talk a little bit about the different type of models there might be in a trend fund. So you’ve told me I can’t do it on a spreadsheet. Presumably that means I can’t use a 250 day moving average and just buy everything under the sun, or sell, or look for squiggly lines in a direction. So what kind of models go into trend funds at a high level? We don’t want to be super complex, but just kind of a general sense.

Russell Korgaonkar:

Most trend signals will use price data. So they’ll use historical prices and they might use things like moving averages and their classic Trend-following signal is the difference between moving average crossovers and the difference between those different moving averages gives you some signal, which you then turn into a position using a response function. So that’s a classic Trend-following signal. There are others that look at price levels, they look at breakout type systems that react much more quickly to particular levels. And then there are others that use different information. So not necessarily the price from that particular market, but perhaps the price from other markets and occasionally other bits of information as well. So there’s quite a large genre of signals that people use. Some things originally to your point, someone would’ve squiggled it out on a piece of paper and they would’ve kind of tried to establish, does this pattern make sense? And then it’s a case of testing it over lots of data and then establishing confidence in a signal.

Peter van Dooijeweert:

So we are both at a conference in New York that Man hosted a little while back. And I remember because you cleverly ducked out before the Q&A on my presentation, which was on risk mitigating strategies and trend obviously fits in as a potential risk mitigating strategy and a diversifier. But anyway, at the end of that talk, an investor asked me, “Why does trends still work? After all, AHL’s been doing this for at least 30 years, it’s an academic literature. So what is it about trend that’s still effective?”

Russell Korgaonkar:

One of the examples I kind of like to point to, because it’s an example of why I think the system’s fairly enduring, was this discovery several years ago about this stone tablet from 5,000 years ago and it recorded the price of corn-prices in Sumeria

Peter van Dooijeweert:

[laughs] Was it up-trending at the time?!

Russell Korgaonkar:

And you could take these corn prices and they were written over years and years and years. And if you looked at the time series of those corn prices in ancient Sumeria, they exhibited really strong trends. And another example that I have because it resonates with my kids is that they find something that they’re into. So they trade these cards and there’ll be a particular card that becomes popular. And all of a sudden the value of that card goes up. And really both of those things are indicative of the fact that prices by their very nature are driven by behavior, and behavior in its nature is very, very fun following. So it will take a lot to stop Trend-following working because of those very natural reasons for trends to happen. And the other kind of important point to all of this is Trend-following’s really not a very good strategy.

Russell Korgaonkar:

So if you try running Trend-following on a single market, you’ll find that most of the time, it looks awful, that you are buying high, selling low, buying high, selling low, and that costs you money. And you have to be very patient until the price then starts really moving. And then you make nice outsize returns, but you need to be able to have some patience and you need to be able to build big, robust portfolios. And if you do all of that, then you can get the system to on average work. So I think that’s probably the reason why it’s been around for a long time and it’s likely to be around for quite some time to come.

Peter van Dooijeweert:

Yeah, part of that too, is the multi-asset bit matters, right? If we’re just confining yourself to one or two assets, you run the risk of those assets doing nothing for a while, akin to commodities for 10 years.

Russell Korgaonkar:

Yeah, and that’s certainly one of the challenges of Trend-following. And I’ve seen it in my career. There can be certain markets that are stuck in a range for a long time. And it’s easy to convince yourself after some time that there are reasons why this thing will never move too much again, and you are foolish to be Trend-following it, and you give up. And then at that point that you give up, then it starts to trend magnificent fashion. So is it strategy that requires some patience and in particular, it requires diversification.

Peter van Dooijeweert:

Yeah, 2022 is a great example of all this, because inflation is new. And so I’m curious what your thoughts are about market regimes and where trend might generate some returns in changing regimes, and what is the environment for trend?

Russell Korgaonkar:

Yeah. So regime change in markets. It’s one of those things that can be a challenge to many strategies. It can definitely be a challenge to investors. Inflation at it’s heart is a measure of price change. And price change can be a challenge for investors and it can be a challenge for people clearly, and it can be a challenge for the economy. But if you think about the nature of trend, well, price change is exactly what trend needs. It needs prices to move. And what you tend to find is if you get price change happening in one part of the market ecosystem, it affects other parts and prices tend to, if you get the dollar moving, for example, it can affect commodity prices. If commodity prices move, it can affect equity prices, and bond prices, and so on. So inflation as a phenomenon, I think is probably on average, supportive for trend. And it’s quite a challenge for other things.

Peter van Dooijeweert:

Yeah. I know a lot of investors talk to us and Man Solutions about how, well, how should I position in commodities? I know they’re supposed to work in inflation, but if I look at this year, energy’s up a ton and metals are down a ton. And so how does trend navigate that right? It sounds like you’re making money off of inflation, but if you’re long metals, you’re not, right? You’re losing money. So how does that all work out this year?

Russell Korgaonkar:

Yeah. The markets are never straightforward and it’s never the case that everything goes in one direction for long enough that it is easy to make money, and then it’ll kind of calms down and goes in the opposite direction. Things move in different ways based on different bits of information. The key for me actually is to abstract a little bit away from that and just think about uncertainty and volatility. And as trend followers tend to uncertainty, again, it’s a measure of price movement, and Trend-following is a system that likes prices to move. So I don’t think you need to get too cute or too into the details of about if a metal is going up, or oil’s going down, or all of the intricacies. And rather just look at the whole, the bigger picture, and the trends that exist overall.

Peter van Dooijeweert:

When we talk about macro funds, especially discretionary macro funds, they have returns kind of all over the place. But some of them are a bit doing what you’re doing after all, right? We hear certain big macro PMs. Some of the famous ones use things like Elliott Wave. How does what they do compare and contrast to what you do, and is it kind of complementary to what you do, totally different, or how should I think about that sort of relationship?

Russell Korgaonkar:

Well, there are many different types of strategy and signal that people can use. Some of them, carry based strategies or short vol strategies, that they tend to prices to not move that much actually. They like spot prices at the very least to stay fairly static and then they’ll pick up some carry based on the shape of the forward curve. And those types of strategies tend to do quite badly when you get lots of volatility and you get big turning points. Discretionary macro can be clearly a big mix of things, and there’s more fundamental information that goes on. There might be a mixture of some trend-like behavior in those strategies. But the difference with systematic macro is it just focuses on the systematic trend, just focus on the trend falling part.

Peter van Dooijeweert:

And so does that mean you guys need vol? If there’s no vol in the market, lights out?

Russell Korgaonkar:

Yeah. If there was no vol, there’d be no price movement at all, and that would be bad news for trend followers. Luckily, there’s never no vol.

Peter van Dooijeweert:

So if I go back to…

Russell Korgaonkar:

If there’s no vol, it’d be lights out across the market.

Peter van Dooijeweert:

If I go back to 2017 or other years, obviously this has been a big year. Other years, you’re still generating return in trend strategies, so it didn’t seem all that volatile. I’ve been vol PM and I remember not making lots of money during some of those years, especially long vol. So where did it come from?

Russell Korgaonkar:

Where did the recent…

Peter van Dooijeweert:

Returns from like 2014, ’15, ’16 and more… Again, they’re lower, but if you’re looking for vol, there wasn’t any vol. So what’s the difference between now and then?

Russell Korgaonkar:

Well, I don’t know there wasn’t any vol. There was still some, so prices obviously still needed to move to a degree. Those years were in general, a bit more tricky for Trend-following, at least in the G10 most liquid markets. ’14 was okay, but ’15, ’16, probably a little bit more tricky for basic trend. Our approach or the reason why we could do a little bit better in those years was diversity across two axes. One is the markets that we trade and the second is the signals that we employ. So I think if you’ve got a year like this year, the sweet spot has been fairly basic Trend-following on the core markets. But if you want something that is a bit more reliable, a bit more all weather, a bit more likely to work in those years where volatility’s not quite so high for example, you need a more diversified approach.

Peter van Dooijeweert:

And does the Fed have an impact? Did the Fed take away things from you to do in those years versus now who’s given you opportunity?

Russell Korgaonkar:

Yeah, I think so. I think not just the fact that the Fed acted as a backstop to markets, but the fact that people believed that the Fed would act as a backstop to markets. All of that suppressed tails in markets and Trend-following likes things to be able to move. So if the actions of a central bank or even the perceived actions of what they’re going to be are likely to be counter trend, i.e., if things start to get more difficult in markets, then you’ve got this central bank to step in to provide a cushion. All of that as you said, dampens volatility, it dampens price moves, and it makes it more difficult for markets to break out of a range and to trend.

Russell Korgaonkar:

So it was certainly the case that that made the environment a bit more tricky for the last 10 years. Do I think that’s changed in the last couple years? Yeah, I do, and I’ve been saying it for a few years and it is always difficult to make prognosis that last more than a couple of days let alone years, but it’s certainly the case now is, as we all know. The central banks have talked about it. There’s no more forward guidance. The central banks are dictated by the data and that allows for things to move. So they’re not going to be there at the moment. If you’ve got your high inflation, then their arms are tied and they need to react to data.

Peter van Dooijeweert:

So digging into this year’s returns, not so much specific returns, but a bit of positioning. I find it pretty intriguing because obviously trends strategies have made money. So that means they’re probably not long bonds and equities, which most people are, right? Most people have a huge core portfolio of bonds and equities. They may have some things around the edges. And so I’m curious to what extent trend has been a diversifier, and to what extent you think it’s been corrective of those positions? And that’s two different thoughts. You’re getting rid of something I have or you’re adding something I don’t

Russell Korgaonkar:

I think there are times like this year, like the first half of this year, where having genuine diversifiers for portfolios is very important. Clearly in a year in which most assets, not commodities, but financial assets have really struggled, and the trend has been negative and you’ve taken negative positions, you then become very, very complimentary to a long only portfolio. There are times when the trends will be positive and it will feel like you are less complimentary, but in order to make an overall balance system that can provide complimentary behavior in the tails, but also positive performance, you need the whole package. And I think this is what investors really… That’s what people want. They want diversifies, but they don’t want diversifies that are a massive drag in expectation. It’s very, very difficult to accommodate those things.

Peter van Dooijeweert:

And I think part of the diversification part that I always find interesting is I really don’t know where South African currencies should be. And yet a Trend-following strategy gives me exposure to that. But I really want to focus on the first half of the year, really about bonds and equities, and what did trend do in bonds specifically for the first six months of the year and how has that have helped?

Russell Korgaonkar:

Well, I think a lot of people who are active in the markets right now have hardly seen a bear market in bonds. They’ve been used to bonds being not only a diversifier and a protector of portfolios, but also having positive performance. So this first half of this year has been a real shock to bond investors in general. And I think the Sharpe Ratio of bonds in the first half was something like -5, having been a kind of solid +1.5 for years and years and years. It’s only -5. So trend strategies would’ve noticed that. They would’ve seen the direction of travel of bonds. They would’ve got into short positions and those short positions are not just a generic, “Will short bonds and every single bond across the curve.” In some places, bonds have been a bit more durable and other places they’ve been a lot more challenging. So you’ll have this kind of nuanced portfolio.

Russell Korgaonkar:

But the idea being that what you are buying with trend is not a short bond portfolio. It happens to have been short bond on average the first half of this year, because they’ve been going down. But it’s the dynamic that you want because these reversals is something that I come back to a lot, because I think it’s a feature of markets that is really not appreciated. But reversals like this, i.e., the U.S. 10 Year, going from it’s low, which was probably about…

Peter van Dooijeweert:

50 base?

Russell Korgaonkar:

Something like that, right? Up to over 3% this year. It doesn’t just kind of flip up to 3% overnight. It takes lots of information, lots of movement, and lots of change of direction of the economy and policy for that change to happen. So it takes some time. So what trend does quite nicely is it says, “Look, this is a challenge. For you as a bond investor, your challenge is not it going from 50 and jumping to 70 or whatever the short term moves likely to be. It’s, what’s my tail when it goes to three, or four, or potentially higher. Have you got a plan for what you should do if that happens?” And trend kind of encapsulates that plan for you to a degree that it says, in that environment, which might maybe challenging for a static portfolio, it’s actually pretty good for a dynamic trend type portfolio, right? It needs prices to move and hence in that environment tends to do quite well.

Peter van Dooijeweert:

And I think in that sense, it shows up as a risk mitigator. And then I would flip to the other side on the diversifier bit, right? So looking at the kind of shape of how commodities have gone this year, energy and metals, it’s interesting that it’s diversifying. And I’d be curious to hear your thoughts about the diversification properties of what energy has done for inflation, and then how metals looks in terms of positioning over the year, because it’s sort of done a bit different than energies, right? Hasn’t been supported by the war per se.

Russell Korgaonkar:

Yeah. Metals has been different actually post the invasion, and actually metal prices have suffered quite significantly in the last few months, which is more of a China demand story and less of a supply story. Clearly for energy prices globally, that news event coupled with others are a supply challenge. And that’s going to cause a shock upwards, the prices, as has happened. And therefore the point I suppose, that you are making is, it’s a bit more nuanced than saying commodities is a good inflation hedge, right? And in that period postwar, actually you had incredibly high surprises to inflation. So upward inflation, surprises to inflation, yet falling metal prices, which goes to show that it’s a bit more nuanced than just saying commodities is a good inflation hedge. And we’ve had several of them, and Bitcoin was supposed to be a good inflation hedge, right?

Peter van Dooijeweert:

Yeah, exactly.

Russell Korgaonkar:

Until it was absolutely terrible.

Peter van Dooijeweert:

Yeah. I’ve heard some people say it’s been a great year for trend. When should I take profits? Obviously it’s [inaudible 00:25:02]. What would your thoughts be around that?

Russell Korgaonkar:

It’s one of those constant psycho drama, I suppose, psychological challenges that people have about timing investments and timing markets. And in my experience, is an incredibly difficult thing to do. And in fact, the waiting for the price to sell off before you buy is counter trend. It’s the opposite to trend. So on average, a trend tends to work, then that tends not to work. I think the best approach, the approach I would always recommend is, think about your best long term portfolio and try to get into that as quickly as you can. That’s what you should be doing. And the timing bit is very noisy and very difficult.

Peter van Dooijeweert:

And it probably ignores the fact that trend is dynamic. If you said you came in March, trend is in inflation. And if I look at trend strategies now, they seem to be mixed, right? There’s some positions that look inflationary, some positions of deflationary. So I think there’s a misconception about that.

Russell Korgaonkar:

That’s right. So you’re not buying a portfolio. If you’re buying trend, you’re not…

Peter van Dooijeweert:

Value.

Russell Korgaonkar:

Yeah, exactly. You’re not buying short bonds, and long oil, and short metals, right? That might happen to be the case right now, but in next week that might be very different. So you’re buying a dynamic strategy.

Peter van Dooijeweert:

Yeah. Maybe that the argument is it’s a bit of an all weather strategy in quiet times, but something that does pretty well in volatile times. But how much of that is within your control? You can’t predict markets, you say so all the time, you’ve said it a million times. So what’s within your control and how does that make trend fit in my portfolio better? Do I need it to be volatile?

Russell Korgaonkar:

As you rightly said, none of us know what’s going to happen tomorrow, let alone next week or in a year’s time, or five years time. So all we’re doing are maximizing our chances of success and that’s the same within a Trend-following portfolio. We’re trying to maximize our chances of success and minimize our chances of things going badly wrong. And the way that we would do that is to think about improving all the content that we have, trading as efficiently as possible, being as diversified as possible, and controlling tail risk. Those are ingredients of putting together a great portfolio. And then, the portfolio should be robust to whatever happens to be coming down the road. And that’s all we can do.

Peter van Dooijeweert:

Yeah. I think that’s a great spot for us to finish. It does remind me a little bit of a comment you once made that one good year as a result of five years of hard work. It fits into that. And it’s clearly been that kind of year. Well, thanks for joining us Russell, it’s been a nice intro chat to trend.

Russell Korgaonkar:

Excellent. Thanks very much, Peter.

Peter van Dooijeweert:

So thinking about trend strategies, I’d also be curious how they compare to other systematic or discretionary macro strategies, specifically discretionary macro, where they may use carry type strategies or other kind of Trend-following signals themselves.

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