Monday, January 12, 2009

Does Trend Following Work

Richard Widows wrote in article in the about trend following strategies in mutual funds. Basically, he claims that they don't work. For his proof, he listed a group of funds with high returns in 2007 and poor returns this year. I do agree that chasing performance doesn't always work especially with sector, single country & regional funds but I don't think that should keep us away from trend following models that do work. I have back tested many trend and momentum models in stocks, funds and commodities, and if done correctly, they can be quite rewarding.

Widow's simple strategy was picking the fund with the highest return. If he had narrowed down his choices to diversified domestic and international funds, I'd take a guess that the returns of those funds would have been fairly OK in relation to the broad market. If you wanted the big returns, the portfolio would need to trade much more frequently, say quarterly or every couple of months (depending on the fund's short term redemption fees). Momentum changes throughout the year and I have found out that by following the momentum through the year you can piggy back on its returns and still perform better than the broad market indexes.