Are markets that are good for trend good just because they have also gone up a lot, or because carry, or...

I have a friend, ex-colleague and TTU co-host who runs a fixed income focused CTA. We have regular coffees (he pays, so his fund is doing ok) and one of our favourite topics for arguing debating making polite conversation about is why fixed income is so much better for trend than anything else. He's biased, but then arguably so am I; I started my career trading rates options, and we both managed AHL's fixed income portfolio (though not at the same time).

Certainly if you looked at the performance of fixed income it looks good! Consider this extract from my fourth book, tables 37 and 38:

Only vol is better, and that is just two markets. But then, bonds have been a great investment on a long only basis. The data in that book covers a period when bond prices could very easily be summarised as "number go up!". Here are tables 10 and 11 from the same book:

Bonds have the highest Sharpe Ratio on a long only basis (actually it's long only with position sizes adjusted daily for vol: a constant forecast of +10). 

But still, there must be something else going on here. Equities have also done awfully well long only (SR 0.46), but they have the worst trend following performance of all. FX has had crap SR long only, but did pretty well trend following. What's more, it will probably be useful to distinguish between different kinds of tailwind from secular up trends: 

• Price go up (or down, since if we're trend following long/short we are cool with that, c.f. vol)
• High Positive carry (or negative, same reasons)

Of course there are fancy ways of dealing with this, like CAPM style regressions (of which there are plenty in the book); but let's keep things simple here with some scatter plots.

What is being scattered? Well on the y-axis let's do SR of trend following, and on the x-axis the SR of the long only adjusted price return, spot price return, or cumulated carry return (the difference between spot and adjusted price). Each scattered point will represent the returns of one market over a five year period, and I colour the point to indicate the asset class. And we'll also need to do different graphs for each speed of trend following.

Messy python (requires psystemtrade)

Fast trend (momentum 8)

We would expect for faster momentum to have a relatively weak relationship. Let's see:

Yup, nothing there.

Medium trend (momentum 16)

Perhaps the start of a slope there, but not for carry.

Slow trend (momentum 64)

So adjusted prices look good, spot prices less so, and carry not much going on. Don't forget that adjusted is mechanically spot+carry, but over time that addition will make sense if they are uncorrelated. It looks like adjusted prices show clearer trends than eithier of the components do.

But is there anything special?

This doesn't tell us whether there is something special about bonds, equities or FX. Let's repeat the plots for momentum64 but without the scatter points; instead we fit a regression line to each asset class and plot that.

Now that is the money shot for this blog! We can see a clear split:

• Bonds, FX, Metals, Vol: We can convert adjusted price drift into trend SR, with a slope of around 0.9. Note: The vol line in green is the one almost perfectly aligned to the orange line going up to SR 1.0 on the x-axis.
• Ags, Energies, Equities: The relationship is much weaker 

What about the other two types of prices?

We can see there is a consistent effect in spot prices, but carry is much weaker. The exception is vol; much of the adjusted price downtrend in vol comes from the vol premium which is basically carry on the futures curve.

I won't do everything, but here are the adjusted price plots for the other two speeds.

Although the vol line has a worse intercept, the same pattern of the relationship is present.

Summary

To an extent, secular up(down) trends in asset prices make it easier to make profits from (slower) momentum. The effect is roughly 0.7 to 0.9 units of trend following SR for every unit of secular drift depending on the speed of trading. And it's remarkably consistent across asset classes that fall into this category: they are not energies, equities or ags. So there is nothing special about bonds; but there are two distinct types of asset classes. 

Here is another view: a distribution of trend SR returns in five year blocks by asset class for momentum64:

And combining with this plot, showing the distribution of adjusted price returns (SR) in five year blocks by asset class:

One last scatter plot of the medians SR from the above two plots:

We can say:

• Bonds, FX and Vol did as expected, converting trends of various strengths to momentum trend SR (they lie on an imaginary line running diagonally upwards)
• Metals, which we know is also a strong trend convertor, did even better than expected 
• Equities is definitely an underperformer as we'd expect from a poor trend convertor.
• Energies and Ags seems to have got lucky; though they are not great trend convertors they did better than expected (lying just above the imaginary line).

Is this trend conversion a property of the asset class, or just a fluke? I dunno. But it doesn't look like there is anything special about bonds.