Research Affiliates demonstrates how trend-following can be a tightrope act: dialing up the strategy’s prized positive skew for crash-era payoffs invariably chips away at its Sharpe ratio, so allocators must decide how much smooth return they are willing to sacrifice for tail-risk insurance.
Walking the Tightrope: Trend Following’s Tricky Tradeoffs
Research Affiliates
Jim Masturzo
Research
20 Pages
Key Takeaways
Tail protection through positive skewness: Trend-following strategies can provide significant gains during market downturns, acting as a form of portfolio insurance.
Trade-off with Sharpe ratio: Achieving higher skewness often results in a lower Sharpe ratio, requiring careful consideration in strategy design.
Importance of strategy design: Decisions around signal construction and portfolio weighting are crucial in managing the Sharpe-skew trade-off effectively.
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