Trend Following with Managed Futures

CHAPTER 13

Benchmarking and Style Analysis

Return-based style analysis is a commonly used technique to identify a fund’s exposures to a mixture of indices or factors. It can be used to evaluate a fund’s performance, to reveal asset allocation tilts, and to detect style drift. Originally proposed by Sharpe (1992) for mutual fund return analysis, Fama and French (1993) would go on to develop a similar methodology, based on three factors, to explain the cross-section of stock returns. This chapter develops the same methodology for trend following. It is worthwhile to note that, while focused on the strategy of trend following, this type of analysis can also be generalized to other strategies. Using the divergent trend following index (DI) as the baseline strategy or “market” portfolio and three construction style factors similar to Greyserman, Kaminski, Lo, and Yan (2014), this chapter develops a framework and discusses applications for return- based style analysis in managed futures.

The trend following style factors are not based on index returns; they are constructed similar to those of the Fama and French (1993) three-factor model. A framework of this kind is necessary as work on hedge fund–style analysis focuses only on higher interstrategy (as opposed to intrastrategy) variations. More specifically, in the literature, hedge fund returns are often characterized by the returns of buy-and-hold strategies of assets manager portfolios, returns attributed to their dynamic trading ...