Trend-following strategies are often viewed as primarily defensive, while in other cases they are neutral or even a drag on portfolio returns. This study aims to challenge this long-held perception by exploring the drivers of crisis alpha in trend-following and assessing how to preserve its defensive characteristics while enhancing overall return potential. Specifically, we examine whether crisis alpha is driven by relative value investments within asset classes implied by trend positions, or by beta timing decisions (i.e., going long or short across asset classes). We argue that this is crucial for understanding how to improve the stability and overall returns of trend strategies while retaining their valuable defensive properties.

As shown in Exhibit 1, trend-following strategies, represented by the SG Trend Index, have performed very strongly relative to the S&P 500 during equity drawdowns, especially during major financial turmoil since 2000. This performance is the foundation of the term "crisis alpha," which captures the core return characteristics of trend strategies.

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In our research, we construct a hypothetical trend-following model and decompose it into beta timing decisions (long or short, and magnitude) and relative value decisions (long or short one market relative to another). We separately evaluate the results of these two hypothetical sub-portfolios and find that 76% of the risk and 78% of the excess returns come from beta timing rather than the relative value component. Beta timing decisions also drive most of the typical characteristics of trend-following approaches, including crisis alpha features. Specifically, we find that, on average across asset classes, the beta timing component has a negative correlation with equities that is more than twice as strong as that of the relative value component. These results raise the question: is it possible to enhance trend strategies with richer alpha signals while preserving the defensive characteristics of crisis alpha? Our research shows that it is indeed possible to completely replace the relative value component with a significant allocation to another relative value strategy with a higher Sharpe ratio, while retaining most of the crisis alpha benefits of the strategy. This is the key finding of this paper. If you want the crisis alpha of trend-following and also want a strategy with higher average returns—especially during equity market booms—our analysis suggests you can have both.

Conclusion

In our research, we construct a hypothetical trend-following model and decompose it into beta timing decisions (long or short, and magnitude) and relative value decisions (long or short one market relative to another). We separately evaluate the results of these two hypothetical sub-portfolios and find that 76% of the risk and 78% of the excess returns come from beta timing rather than the relative value component. Beta timing decisions also drive most of the typical characteristics of trend-following approaches, including crisis alpha features. Specifically, we find that, on average across asset classes, the beta timing component has a negative correlation with equities that is more than twice as strong as that of the relative value component. These results raise the question: is it possible to enhance trend strategies with richer alpha signals while preserving the defensive characteristics of crisis alpha? Our research shows that it is indeed possible to completely replace the relative value component with a significant allocation to another relative value strategy with a higher Sharpe ratio, while retaining most of the crisis alpha benefits of the strategy. This is the key finding of this paper. If you want the crisis alpha of trend-following and also want a strategy with higher average returns—especially during equity market booms—our analysis suggests you can have both.