Trend-following hedge funds are off to a strong start in 2024. Does the strategy deserve a spot in your portfolio?

By Joseph Adinolfi

They have more than doubled the gains of the S&P 500 this year, before fees are factored in, according to data from Société Générale

Trend-following funds continued a run of strong performance in April, even as a selloff in stocks disrupted one of their biggest moneymaking trades.

While stocks retreated from record highs last month, other trends across markets remained largely intact, helping to offset the hit from stocks' retreat, according to data from Société Générale.

The U.S. dollar continued to march higher against a basket of rivals like the Japanese yen (USDJPY), euro (EURUSD) and Mexican peso (USDMXN), helping to offset weakness in stocks. Commodities like gold (GC00), silver (SI00) and copper (HG00) also climbed in April, even as they faltered late in the month.

Trend-followers' short positions in bonds also remained profitable, as Treasury yields BX:TMUBMUSD10Y continued to climb on expectations that the Federal Reserve will need to delay expected interest-rate cuts.

As a result, the Société Générale trend-following index finished the month up 2%, widening the index's outperformance against both the S&P 500 and a 60-40 basket of U.S. stocks and bonds, according to Dow Jones Market Data. Trend followers were up 14.5% year-to-date as of Tuesday's close, their strongest start since the year before last. The S&P 500 SPX was up 5.5% over the same period at 5,035.69.

After trailing the S&P 500 and other global stock-market barometers for years, trend-following funds saw huge gains in 2022 as traders piggybacked on a slump in stocks and bonds, as well as a rally in the U.S. dollar that carried the currency to its strongest level in decades.

The SocGen trend-following index beat a U.S.-based 60-40 portfolio by 44 percentage points that year, its widest calendar-year outperformance since SocGen started collecting data in late 2001, according to a MarketWatch analysis of data from SocGen and Dow Jones Market Data.

But their performance turned lackluster in 2023, as a stock-market rebound took a while to get going, while the collapse of Silicon Valley Bank in March sparked a rally in bonds that reversed later in the year, according to a team of analysts at SocGen that publishes regular reports on the space.

SocGen's trend-following index fell 4.2% in 2023, compared with a gain of 24.2% for the S&P 500 and a 17.4% gain for a U.S.-based 60-40 portfolio.

But in 2024, they are once again on track to outperform as markets from stocks to bonds to currencies to commodities have moved consistently in a given direction, creating what one longtime trend-following manager described as an ideal environment for the strategy.

"Trend following captures trends, so it does well when there is a lot of persistent moves in markets," said Chris Reeve, director of risk at Aspect Capital, a London-based commodity trading advisor, during an interview with MarketWatch. Aspect's trend-following Aspect Diversified fund is up more than 20% year-to-date. Commodity trading advisors, or CTAs, as they're more commonly known, are a type of trend-following fund that mainly trades in futures markets across stocks, bonds, currencies and commodities.

This strong performance over the past few years has inspired discussions among Wall Street professionals about whether the average investor should consider adding exposure to trend-following strategies in their portfolio.

According to SocGen, the trend-following index has underperformed the S&P 500 dating back to late 2001, the earliest data available. But Dow Jones data show these funds have outperformed the 60-40 portfolio over the same period.

That the strategy's returns are largely uncorrelated with stock- and bond-market benchmarks makes it an attractive option for diversification, according to a team of researchers with Man Group, a London-based hedge fund, who published a paper extolling trend-following funds last month.

According to the paper, trend-following funds have a long-term record of providing stocklike returns with "zero long-term correlation" to traditional assets. They also tend to outperform during a crisis, making them a valuable hedge against weakness in stocks.

The three best years for systematic funds dating back to 2001 were 2022, 2008 and 2002 - all years when stocks performed abysmally, SocGen's data showed.

This could come in handy considering that over the past three years, stocks and bonds have increasingly traded in lockstep, diminishing bonds' utility as a buffer against periods of weakness in stocks.

Adding exposure to trend-following strategies could help to compensate for this, the researchers said. But exactly how large that allocation should be is open to interpretation.

-Joseph Adinolfi

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05-01-24 1106ET

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