CHAPTER 6

The Role of Interest Rates and the Roll Yield

Chapter 2 presented a review of futures markets, futures trading, and the managed futures industry. Given this introduction, it is clear that issues related to trading on margin, the impact of collateral, and the associated costs of borrowing across markets can clearly impact trend following. In addition, trends in interest rates can also drive trend following performance over time. Just as equity crisis can cause market divergence, moves in interest rates can also cause market divergence. In recent times, markets have been plagued by a historically low interest rate environment. Given the success of trend following during the long period of decline in interest rates since the 1970s, it is only natural that some investors are concerned about how trend following would cope with rising interest rates.

The potential impact of interest rates comes from two main sources: (1) collateral yield and (2) trends in futures prices (especially bond futures). (See Figure 6.1.) Collateral yield is the return that is earned for collateralized positions via margin accounts. Futures strategies trade on margin; some or even most of the invested cash is typically invested in short dated government debt such as U.S. Treasury bills. If invested capital includes noncollateral investments, it is also called earned interest on cash management or the cash return. During periods when interest rates are high, for example in the 1980s, the interest ...

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