The trend really is your friend

Each week, a professional investor tells us where he’d put his money now. This week: Chris Clarke, managing partner and CIO at Trend Follower Lawrence Clarke Investment Management LLP.

Momentum investing has many trade names. Perhaps the most accurate is ‘trend following’. There are, of course, numerous trend-following investment managers in existence but, as at the summer of 2010, assets under management by the sector only represented about $150bn-$200bn – less than 10% of all assets managed, globally, by hedge funds. This is striking, not least because these funds have vastly outperformed most other investment strategies throughout history.

As a strategy, trend following goes back centuries, but many modern-day trend-following funds also have a history dating back to the late 1970s and early 1980s. Many have track records of compound annual returns of more than 20% a year, for a period of more than 20 years.

Their secret is as striking as their performance: there is no big secret! Their methods and rules are simple. Yet they keep on performing. The latest big example of their success came in 2008, when many trend followers recorded annual returns of between 50% and 120% – a year in which it was reported that hedge funds had suffered a bad year. Perhaps the very simplicity of the strategy accounts for its unpopularity in the investment industry.

The year 2009 was tougher for trend followers than 2008, but they don’t expect to make money every year. Instead, they expect to perform well over the longer term – perhaps five to ten years. We should accept that the odd losing year and a degree of volatility are key to their success. For example, if you had invested $100 with your typical trend follower in 2000, you would’ve been likely to have tripled your money – and some have performed better. Compare that to global equities, which have returned a negative or flat performance over the same ten-year time frame (including dividends). There is no comparison.

But isn’t investing about financial gurus, star managers and the next big thing? Poppycock, say the trend followers. The same rules apply to financial markets today as they did 500 years ago. Why? Because financial markets are based on human behaviour – it’s humans who trade them after all – and this will never change. Don’t fight the market direction, forget your personal opinions about where markets ‘should’ be going and focus on going with the trend.

The most important part of the whole trend-following philosophy is risk and money management. Only risk a small amount of capital on any one trade; trade a large basket of global financial markets; let winning trades ride and exit losing trades quickly. Having a plan before you enter a trade and knowing where you’re wrong are vital to success.

Several big trends have developed recently, some even hitting the mainstream news channels. Moves in the grain markets and cotton, for example, have been widely covered on terrestrial television news.

Cotton price

The chart above is a daily closing chart for cotton – prices already having trended up by approximately 100% since August 2010.

Another important point about trend followers is that their rules apply to all types of markets. They don’t just trade one type of market (stocks) – why limit yourself? The more markets you trade the better the chances of capturing a trend.

Trend followers as investment managers don’t really care why the moves happen. They don’t analyse or predict, and they don’t exit their investments until the markets signal that it’s time to get out. A good example was crude oil in 2008 – the market jumped to $70/$80 per barrel, with most analysts suggesting that $100 was not possible.

Next stop was crude oil blasting through $100, $120 and then $140. The trend followers just rode the position all the way, with most then automatically getting expelled as it moved back down through $110 a barrel. They didn’t get out at the top – they never do – but buying at $60 and selling at $110 is still a good trade. There is mileage yet in the old adage that the trend is always your friend!