CHAPTER 12
Index and Style Factor Construction
Each individual trend following system includes a complex integration of risk allocation, signal generation, filtering, and trade execution. Each of these aspects combines to create a somewhat unique yet similar system. As discussed in the previous chapter, daily correlations between programs are often high, yet return dispersion in the cross section can be quite substantial. This provides a unique challenge for an investor as programs often deviate substantially from common industry benchmarks and from other trend following funds. Investors are concerned about performance evaluation, strategy classification, appropriate benchmarking, and monitoring style drift. Without a proper benchmark to compare with, results can be misleading and manager skill is difficult to characterize. A simple comparison to an industry benchmark is often too naive, and peer-based analysis can be relatively subjective. To alleviate this problem, Greyserman et al. (2014) present an analytic framework for performing return based style analysis in managed futures. By focusing on the divergent risk-taking aspect of trend following, their paper provides a direct link between strategy construction and performance in the cross section of CTA returns. In Figure 12.1, the rolling 12-month normalized returns for eight large CTAs is plotted. This plot demonstrates how difficult it can be to compare one trend follower with another.
FIGURE 12.1 Twelve-month rolling ...
