Why Are Investors Buying a Hedge Fund Strategy that Isn't Working?

By Marko Aliaksandr @ Shutterstock.com

Despite evidence that the strategy isn’t working today, investors have plowed $300 billion into hedge funds using “trend-following.” Laurence Fletcher writes about the phenomenon at The Wall Street Journal:

If you’re looking to be a member of my Survive & Thrive club, click here.

Performance among the roughly $300 billion in hedge funds that largely use so-called trend-following strategies has been abysmal. An investor buying into these funds at the start of 2011, for instance, and holding through July this year would have lost 3.4% on average, according to HFR. Over the same period the S&P 500 is up 124%.

“It’s like a lot of industries,” said Matthew Beddall, founder of investment firm Havelock London. “As it’s been successful more people have got involved. Now you can buy a book on Amazon on how to code trend-following.”

Trend-following is a simple concept with complex execution. The underlying idea is relatively straightforward: If a security is going up—usually measured by a short-term moving average rising above a long-term moving average—then it’s time to buy. If it falls below, it’s time to sell. Funds employ armies of Ph.D. scientists to work out exactly when a price move becomes a trend.

Investors have followed trends for centuries. British economist David Ricardo, who amassed a fortune trading markets 200 years ago, was known for cutting his losing positions and running his winners. Trend-following took off as a hedge-fund strategy in the 1980s, when commodities brokers automated trading with computers to look for market patterns.

These funds chalked up double-digit gains during the 1990s and 2000s. And they were one of the few hedge-fund strategies to make money in 2008’s market slump. This performance led pensions and other hedge-fund investors to pour in money.

The strategy has failed to deliver in recent market falls. In January, many such funds made big gains as markets soared, only to lose them and more during February’s volatility-driven selloff.

E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zildjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com To sign up for my free monthly Survive & Thrive letter, click here.