Expected Returns

The trend is our friend: Risk parity, momentum and trend following in global asset allocation

“…Whilst one may argue that developed equity markets have similar risk characteristics, and thus risk parity can only offer minimal improvements, this is not the case in commodity markets. Ilmanen (2011) describes how natural gas and heating oil have exhibited considerably more volatility historically than soybeans and gold, and yet we still find minimal improvement from risk parity. But the Sharpe ratio for the equally-weighted portfolio of commodities (column 1, panel D, Table 4) is 0.28, which is identical to the Sharpe ratio calculated for the risk parity-weighted commodities portfolio, shown in Panel A of Table 4.…”

“…Typical momentum strategies involve ranking assets based on their past return (often the previous twelve months) and then buying the 'winners' and selling the 'losers'. Ilmanen (2011) argues that this is not an ideal approach to investing and that investors would be better served by ranking financial instruments or markets according to rankings based upon their past volatility. Ilmanen suggests that failing to do this leads to the situation where 1 The importance of technical analysis for fund managers is assessed by Menkhoff (2010) the most volatile assets spend a disproportionate amount of time in the highest and lowest momentum portfolios.…”

“…Faber (2009) uses trend following as a means of informing tactical asset allocation decisions and demonstrates that it is possible to form a portfolio that has equity-level returns with bond-level volatility. Ilmanen (2011) and Friesen et al (2009) offer a variety of explanations as to why trend following may have been successful historically, including the tendency for investors to underreact to news and their tendency to exhibit herding behaviour. Shynkevich (2012) questions the more recent effectiveness of similar rules in the US equity market.…”

Breaking into the blackbox: Trend following, stop losses and the frequency of trading – The case of the S&P500

“…And there is now growing academic evidence to suggest that these trend following strategies can produce attractive, risk-adjusted returns (Szakmary et al, and references therein), though Irwin (2005a, 2005b) in reviewing 9 studies using trading rules for commodity futures report mixed findings. Ilmanen (2011) suggests that the typical Sharpe ratio for a single asset using a trend following strategy lies between 0 and 0.5 but rises to between 0.5 and 1 when looking at a portfolio.…”

“…The intuition behind the simple trend following approach is that while current market price is most certainly the most relevant data point it is less certain whether the most appropriate comparison is the price a week ago or a month or a year ago, (Ilmanen (2011)). Taking a moving average therefore dilutes the significance of any particular observation.…”