Profitability and Risk of Market Timing Strategies Using Passively Managed Funds
Authors:   , Evans Tomiko J. K. 
Published: April 2022

The aim of this thesis was to extend previous trend-following literature to consider if trend-following strategies which used unit trusts would have the same improvements in returns, risk-adjusted returns, volatilities, and maximum drawdowns as has been found in previous studies. As unit trusts are only created and redeemed once a day, it could be possible that this delay would have an impact on results, but they are also accessible, relatively inexpensive, and already in use by retail investors. The aim was to discover the mechanics of trend following and to investigate the creation of a strategy which would be of benefit to a UK-based investor. Chapter 2 confirmed for unit trusts the previous findings that over long periods, trend following was able to reduce volatility, improve maximum drawdowns, and increase risk adjusted returns for the HSBC FTSE 100 unit trust over 21 years. Previous trend-following studies invest in a cash-like asset when signalled to be out of equity markets. This thesis instead reviewed the use of a UK government bond as well as cash when not invested in equity markets. When used in combination with the FTSE 100, the inclusion of gilts in the strategy increased returns and risk-adjusted returns while continuing to offer a large reduction in risk measured through volatility and maximum drawdown. The typical 200-day moving average was found to be sufficient but was not the optimum strategy for this market over the 21 years studied. Instead, the use crossovers and trading monthly provided the best performances. When reviewed on a yearly basis over 1- 10 years, results for trend following were not as compelling with less consistency in returns and Sharpe ratios, but volatility and maximum drawdowns were still improved. Chapter 3 examined trend following with unit trusts for 7 different equity indexes cumulatively over 1-10 and 15 years. The strategies did not perform as well over the 15 years as they had previously. This was partially due to where the start date of the investments fell in the market cycle. Years which started invested in equities and were able to exit after a fall, such as 2007 and 2008 were able to outperform a buy and hold. Alternatively, if the strategy started around the bottom of the market trough, such as in 2009 and 2016, the strategy had a delayed entry into equity markets which often lead to the trend-following strategy to outperform. This chapter also found that different market characteristics such as low volatility, high returns, and large maximum drawdowns were beneficial for a trend following strategy to be able to outperform. When compared to the underlying equity market, the only way that a trend-following strategy will be able to outperform is if there is a large drawdown with which it can exit. Otherwise, the best the strategy can do in an upward market, is to equal the buy and hold. The addition of UK government bonds to the trend-following strategies was able to provide additional returns even when used as the alternative investment to international equity markets while continuing to also provide similar and significant measure of risk reduction as a trend-following strategy which instead moved to cash. As different markets have different characteristics, so too do they have different optimum strategies. A 200-day moving average again would suffice, but just as investing in international markets allows for greater diversification, these different characteristics also allow for different optimum strategies. Chapter 4 created trend-following portfolios using unit trusts and found that although the results were mixed for the individual markets, the combination of assets into a portfolio was able to provide improved risk-adjusted returns, volatilities, and maximum drawdowns compared to the individual markets and a 100% equity buy and hold portfolio. When compared to buy and hold 60% equity and 40% cash or gilts portfolios, the trend-following portfolio was able to deliver similar levels of risk reduction with much great returns more similar to the 100% equity portfolio. The trend-following portfolios were therefore able to deliver reductions in risk above that which was available through diversification alone. The gilt versions of the portfolios again increased the average returns and risk-adjusted returns while still providing significant levels of risk reduction. A review of the market disruption caused by the spread of the coronavirus found that trend-following was adept at exiting a falling market and reducing risk, but the delayed reinvestment impacted overall performance.