Even more impressive are the hedge funds that made money in both 2008 and 2009. Market timing is hard but some have the ability to do it. The best way to evaluate any investment strategy is its return on risk. Even with the recent stock market rally, the return on risk of long only funds has been poor. As usual the mythical equity risk premium hasn't worked. Is it zero? Is it negative? I don't know but it is too unreliable to match institutional liabilities or for individual investors wanting to grow and preserve their retirement savings. Invest with managers that have the skills to MAKE MONEY when things go pear-shaped - ie when markets or economies go bad.
All trends end. Sad how those who argue trend following has no value continue to advocate long only equity funds because of an upward trend that can supposedly be extrapolated far into the future. As the volatility of previous years has shown, it is pear-shaped times that provide the true stress test for risk management. The trend is your friend until it ends. As we saw with stock, credit and commodity markets this decade, the more strong and long lasting the trend, the more violent the end.
Unfortunately the crowd STILL uses normal assumptions which is fine UNTIL things stop being normal. Pear-shaped situations require pear-shaped analysis. I'm not a quant but I've always preferred non-linear pear-shaped equations rather than linear equations since they capture the initial quasi-linear uptrend and then model the volatile end game. WE DON'T KNOW THE FUTURE but we do know there are always securities to short sell and others to buy.
The simplest pear-shaped formula is y^2=x^3-x^4 which only has solutions in the real world for inputs between 0 and 1. We can define the beginning of anything at zero and ending at one. Identifying and jumping onto a trend is relatively easy. Lots of people make money in bull markets. But knowing when to get out and reverse into a short position is what separates the alpha players from the beta repackagers. Since most phenomena are non-linear it stands to reason that linear models are of limited use.
Many physical processes exhibit pear-shaped characteristics. The universe is pear-shaped. Time is certainly pear-shaped. Just ask Stephen Hawking. Atoms are too. If the largest and smallest systems are pear-shaped, it would seem possible that finance could also exhibit a similar form. Bonds and loans are great assets till the borrower defaults. Mortgages are fine unless real estate goes pear-shaped. Bull markets last longer and have low volatility while bear markets are quicker but often eviserate years of "gains" from the prior bull market.
Recently I reread a couple of books on the economic shape of the world. One was The
World is Flat by Thomas Friedman. While interesting, the premise is incomplete. The world is actually pear-shaped and only gives the ILLUSION of flatness during the easy times. Perhaps I should write a book called The World is Pear-Shaped. Nascent protectionism may be slowing the globalization trend. David Smick's The
World is Curved is insightful and we need techniques to prepare for the different scenarios beyond the curve.
Most economists and "passive" index fund groupies sell a rosy view of a future that we can apparently look forward to. I hope they are right but CONSISTENT CAPITAL GROWTH requires mitigating the downside. Few investors can afford to ignore drawdowns or volatility. Follow the trend? Into the abyss? Many equities drop to zero but NONE has ever gone to infinity.
The life-cycle for businesses shortens all the time. Corporate and even country hegemony is not as long term as it used to be. Typewriters, sliderules and vinyl records all had rising sales for decades but not much "growth" recently as demand went pear-shaped. Innovative strategies that seep into the public domain and crowded trades are prone to end with a meltdown. Bubbles take a long time to form but a short time to end. The best alpha generators are those managers equipped to successfully navigate difficult markets. Successful trend following requires good trade entries AND exits. Invention eliminates the obsolete.
Some absolute return strategies went pear-shaped last year like CB arbitrage and long/short equity. The returns have stormed back this year by those managers with the skills to achieve them. Meanwhile good managed futures CTAs and short biased funds continue to deliver ESSENTIAL negative correlation to their clients. Portfolios need to be structured for ANY possibility including a dystopian long term. Fiduciary duty REQUIRES portfolio construction for pessimistic scenarios. Bear markets or bull markets are irrelevant in robust strategy allocation.
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