Stockholm (HedgeNordic) – Many trend-following strategies have flourished in 2022 amid a persistence of larger trends across several asset classes. The most successful trend followers have made their returns by being on the right side of the market trends in bonds and energies. Lynx Asset Management’s trend-following program has been on the right side of trends everywhere after amassing gains in every traded sector.

Lynx Fund enjoyed its strongest start to a calendar year since inception in May 2000 with a 35.8 percent return for the first half of 2022. The program powering the fund is so far generating gains in every asset class traded. Fixed-income-related and energy-related investments accounted for a good portion of the Lynx Program’s performance in 2022. “While bonds and energies have been highly profitable this year, the program would still be performing very well without them,” says Martin Källström, Partner and Senior Managing Director at Lynx. “Through the end of August, the rest of the portfolio has contributed a positive 13.6 percent gross return as gains have been generated in every sector we trade from currencies to agricultural commodities,” he elaborates. “It has been nice to have made the right calls on bonds and energies, though!”

Diverging Fortunes

While trend-following CTAs as a group have seen a resurgence in performance in 2022, many suffered from lackluster performance despite operating in a trendy environment. But why have trend-followers experienced diverging fortunes this year? According to Källström, “people underestimate the impact of timeframe, asset allocation, and methodology on trend-following performance.” Differences in these strategy choices can result in widely divergent results. “Given some of the extraordinary moves that have occurred across asset classes this year, how and how quickly a manager enters a trend, manages the risk around that trend, and ultimately determines when that trend is no longer in place have had a tremendous impact on profitability,” he emphasizes.

“People underestimate the impact of timeframe, asset allocation, and methodology on trend-following performance.”

Differences in the traded market universe and how managers approach risk allocation and risk management can also significantly impact returns among trend-followers, according to Källström, particularly in a market environment that we have observed in 2022. “While there will always be performance dispersion based on these variables, managers may have been trying to differentiate themselves from the peer group to attract investors in recent years by doing something new,” points out Källström. “This may also be contributing to some unexpected results.”

Staying to Main Objective Amid Continuous Evolution

While constantly developing its trend-following Program, Lynx Asset Management stayed true to its main objective of delivering strong returns with a negative correlation to equities in risk-off environments. “Despite some significant advances in our models over the years, we have remained true to our objective: delivering attractive risk-adjusted returns with a conditional negative correlation to equities in down markets,” emphasizes Källström.

“Despite some significant advances in our models over the years, we have remained true to our objective: delivering attractive risk-adjusted returns with a conditional negative correlation to equities in down markets.”

“The Lynx Program is constantly developing – and hopefully improving; as the market dynamics and opportunity set change, we adapt to the new environment,” elaborates Källström. “Like evolution, these changes occur slowly. Even significant developments – such as the implementation of machine learning models in 2011 – did not markedly change the strategy,” he continues. The team at Lynx Asset Management monitors key performance indicators to ensure that the addition or “retirement” of models does not alter the objectives of the strategy. On average, the Lynx team turns over about one-tenth of the models in the Lynx Program every year as they refine the approach to “the then-current regime,” according to Källström. “Importantly, however, the objective of the program has never changed.”

Trend-Following and Diversifying Models

The Lynx Program relies on a collection of over 45 trend-following and diversifying models. The trend-following allocation currently corresponds to just over 70 percent of invested assets. “Trend-following currently accounts for around three-quarters of the risk in the Lynx Program, not markedly different from what it has been at any other point in time over its 22-year history,” says Källström. “Trend capitalizes on the behavioral biases of investors in a way that makes it a very attractive strategy in a portfolio of traditional investments…it tends to do best when markets are being driven by fear or greed,” he explains.

The Lynx Program uses different methods to identify trends, which are applied across a broad universe of markets and timeframes. Short and medium-term models account for over 80 percent of the program’s allocation to trend risk “as these are quickest to respond to market crises,” according to Källström. “We have remained on the shorter end of the medium-term trend-following spectrum even though extending our timeframe would have allowed us to increase the capacity of the strategy,” he adds. “While we may not always be correctly positioned to profit from an idiosyncratic market shock, we want to be quick to react once one occurs.”

“While we may not always be correctly positioned to profit from an idiosyncratic market shock, we want to be quick to react once one occurs.”

The program, which currently oversees SEK 90.8 billion in assets under management, also employs a number of diversifying models to complement the performance of the trend-following book. “While it can be tempting to include convergent strategies and risk premia (such as outright carry) due to their negative correlation with trend, we avoided these as they tend to perform poorly during market crises, particularly when volatility is expanding,” explains Källström. On this diversifying side of the portfolio, models are developed and selected based on their ability to deliver differentiated positive performance without a short volatility profile. “Each model has unique characteristics and we apply a sophisticated approach to analyze key indicators which influence how risk is ultimately budgeted,” elaborates Källström.

“On a high level, the allocation of risk to our different models is a result of an optimization exercise where we seek to maximize our objective function for the program,” says Källström about the strategy allocation process. While diversifying models are mostly designed to reduce drawdowns in non-trending environments, both trend-following and diversifying models generated positive returns across all timeframes this year.

Are Markets Trendy Enough?

The environment so far in 2022 has been exceptionally attractive for the Lynx Program, but a continuation of the current regime is not imperative for positive performance to persist going forward. “The highest developed market inflation readings in a generation, normalizing monetary policy, increasing fiscal imbalances and geopolitical conflict have all contributed to some exceptionally profitable trends in financial and commodity markets this year,” explains Källström. These issues, however, did not emerge overnight. “Inflationary pressures have been building for years, with many imbalances left over from the global financial crisis over a decade ago. Trend-followers welcome this environment as markets have moved and will likely continue to move as the year progresses.”

“The Lynx Program is designed to adapt to the market environment and only needs markets to move from one level of equilibrium to the next to prosper.”

The environment for trend-following has improved markedly, specifically for a strategy like the Lynx Program, points out Källström. “Importantly, whether the same pressures that have driven markets so far this year continue will not necessarily determine the fate of our strategy going forward,” he continues. Short bond and long energy positions have been the program’s best performing sectors in 2022. For a brief period in August, the Lynx Program also went long bonds and shorted the crude oil complex. “The Lynx Program is designed to adapt to the market environment and only needs markets to move from one level of equilibrium to the next to prosper,” emphasizes Källström. “While I can’t tell you what will happen from a macroeconomic or geopolitical perspective as the year progresses, I’m confident that markets are going to move. We plan on capitalizing on those moves as they occur.”

This article features in HedgeNordic’s “Systematic Strategies” publication.