Expected Returns: An Investor's Guide to Harvesting Market Rewards

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Commodity momentum and trend following

• Many financial return series exhibit positive short-term momentum. Buying assets when their prices have risen and selling assets when their prices have fallen is profitable in many asset classes, including commodities.

• Momentum strategies can be traded on a single asset (trend following) or across assets (long–short trading). One can use many types of momentum signals (past returns, moving averages, breakout, consistency, etc.) and various lookback window lengths (to capture shorter and longer trends).

• For single commodities, the SR of trend-following strategies is typically between 0.0 and 0.5. For a diversified portfolio of them, the SR is between 0.5 and 1.0—at the higher end if volatility weighting is used. However, actual CTAs (commodity trading advisors) rarely have as good SRs as these simulated strategies.

• Momentum patterns likely reflect behavioral factors—investor underreaction to news and overreaction to recent returns (extrapolating past returns). Rational risk-based explanations are less compelling, but I highlight a link between commodity inventories and momentum.

• Trend-following and momentum strategies have been exceptionally good diversifiers to risky assets, performing well amidst equity meltdowns and rising volatility.

• Momentum strategies involve greater turnover than active carry and value strategies. Thus they are profitable only to those able to trade with very low transaction costs.

• Buying past winners using ...