Are Trend-Following and Time-Series Momentum Research Results Robust?

A cura di Wesley R. Gray, Validea Capital Management

When it comes to trend following and/or time-series momentum research, we got ya covered!

A few places to dig in:

As a general theme, the articles above highlight the benefits of trend-following or “time series momentum” strategies.(1)

In addition to the articles above, there are multiple pieces from other authors (Meb Faber, Corey Hoffstein, Gary Antonacci, Invest Resolve crew, Ritholtz crew, AQR crew, and so forth),  all saying roughly the same general thing — “Trend Following works.”

Great, trend-following seems to be a pretty robust phenomenon found across multiple markets, asset classes, and research groups…

Let’s Attempt to Avoid Confirmation Bias

Confirmation bias, or the desire to seek conforming opinions, is a debilitating behavioral bias that can lead to overconfidence and blind spots in investing. We try and avoid this problem, but without a deliberate effort to avoid the bias, we will fail. Trend-following is a great case study. Almost everything we read and write about confirms what we already understood. Having Valeriy Zakamulin post our trend following series (a known trend-following expert/skeptic) was our first move in the right direction. We also highlighted a piece on time series momentum (and our follow-on investigation), which suggested that time series momentum results are entirely driven by volatility weighting.

And now we have another challenge to Time-Series Momentum from Professors Huang, Li, Wang, and Zhou (Guofu Zhou is one of our favorite researchers at Alpha Architect!). The title of their paper is, “Time-Series Momentum: is it There?”

Here is the punchline from the provocative paper:

Overall, the evidence on TSM is quite weak, especially for the large cross section of assets.

Does Trend-Following/Time-Series Momentum Even Work?

The authors discuss a variety of past research papers on time-series momentum but pay particular attention to the Moskowitz, Ooi, and Pedersen (“MOP”) 2012 JFE paper, “Time Series Momentum.” This paper is arguably the first paper in recent memory to crack the top-tier academic journals with a paper on trend-following, often considered by the current ivory tower establishment to be a shoddy attempt to challenge a basic tenant of the efficient market hypothesis, which states that prices always reflect fundamentals.

The data used in the study is similar to that used in MOP and includes 55 instruments from 1985 to 2015. All results reported (unless noted) are excess returns (i.e., collateral returns aren’t included).

The first analysis revolves around so-called predictive regressions, a concept we have discussed in the past (an excel spreadsheet is included), and arguably a crude form of “machine-learning.” The technique is as follows — run a regression of next month’s returns on a given asset (Y-variable) against the asset’s past 12 month returns (x-variable) and see if the beta coefficient is reliably different from zero: If beta<>0, the 12-month returns are assumed to be predictive, otherwise, they are assumed to be noise.

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