Trend-following funds are a type of investment strategy that aims to capitalise on market trends by systematically identifying and trading in assets that exhibit strong upward or downward momentum. These funds rely on quantitative, rules-based models to determine positions, eliminating human discretion and emotional biases from the decision-making process.
Rather than attempting to predict market movements, trend-following funds react to price action, investing in rising assets and shorting those in decline. They operate across various asset classes, including equities, commodities, currencies, and bonds, providing a diversified approach to investing.
How Trend-Following Funds Work
At their core, trend-following strategies use historical price data to identify trends and generate trading signals. The key principles include:
- Market Momentum: Buying assets that are increasing in value and selling (or shorting) those that are declining.
- Systematic Approach: Trading decisions are based on pre-defined algorithms that analyse price trends without human intervention.
- Timeframe Flexibility: Strategies may operate over different time horizons, from short-term to long-term, depending on market conditions and fund objectives.
Key Benefits of Trend-Following Funds
Trend-following funds offer several advantages for investors looking to diversify their portfolios and manage risk effectively. By relying on systematic, data-driven strategies, these funds can navigate various market conditions and capitalise on both rising and falling trends. Here’s how they can enhance an investment portfolio:
Portfolio Diversification
Trend-following funds are often uncorrelated to traditional markets such as stocks and bonds, making them an effective diversification tool. They can act as a hedge during economic downturns, potentially offsetting losses in other portfolio holdings.
Performance in Volatile Markets
These funds have historically performed well during periods of market uncertainty, benefiting from both rising and falling trends. They thrive in times of financial crises, inflationary periods, and other macroeconomic shifts that create price momentum.
Risk Management & Liquidity
Many trend-following funds trade in highly liquid futures markets, allowing for efficient execution of trades. Unlike some hedge funds, they often operate without excessive leverage, reducing exposure to extreme market swings.
Systematic & Emotion-Free Trading
By eliminating human emotions from investment decisions, trend-following strategies avoid common biases that can lead to poor trading outcomes. The use of quantitative models ensures consistent application of trading rules.
Potential Risks and Considerations
While trend-following funds offer strong diversification benefits and the potential for high returns, they are not without risks. Their performance depends on market conditions, and certain environments can pose challenges for this strategy. Investors should be aware of the following key risks:
Sideways Markets
When markets move without clear direction, trend-following funds may struggle to generate returns, leading to periods of underperformance.
Performance Variability
Past performance does not guarantee future returns. Trend-following strategies can be cyclical, experiencing drawdowns during certain market phases.
Complexity & Understanding
Investors need to understand how trend-following strategies work, as they differ significantly from traditional buy-and-hold approaches. The reliance on algorithms and quantitative signals may seem opaque to some investors.
Fees & Accessibility
Some trend-following funds charge higher fees compared to traditional mutual funds and ETFs. Minimum investment requirements and liquidity constraints may vary depending on the fund structure.
Is Trend-Following Right for You?
Trend-following funds can be a valuable addition to an investment portfolio, but they are best suited for investors with specific financial goals and risk tolerance. Understanding whether this strategy aligns with your investment approach is key to making an informed decision. Here’s who may benefit from incorporating trend-following funds:
Who May Benefit?
- Investors seeking to diversify beyond traditional stocks and bonds.
- Those comfortable with systematic, algorithmic trading strategies.
- Individuals looking for uncorrelated returns to complement their portfolio.
Who Should Be Cautious?
- Investors who prefer passive, buy-and-hold strategies with steady returns.
- Those uncomfortable with periods of short-term volatility and potential drawdowns.
How to Get Started With Trend-Following Funds
Before investing in a trend-following fund, it’s important to research different options and review their historical performance. Determining the right allocation size is also crucial, as trend-following should complement a well-balanced portfolio rather than replace traditional assets. Investors should take the time to understand the fee structures and liquidity terms associated with these funds to ensure they align with their financial goals. Consulting with a financial professional can help assess risk tolerance and determine whether this strategy is a suitable fit.
For investors interested in exploring trend-following strategies, Bowmore Capital’s Global Alpha Fund is one option available through Lawsons Wealth. As a fully systematic, quant-driven fund with a strong performance history, it provides an accessible route to alternative investing.
Contact us today to learn more about whether trend-following funds are the right fit for your portfolio.
