Institutional investors looking to add non-correlating strategies that have historically done well when markets are in turmoil often choose to invest in commodity trading adviser strategies, particularly in what is known as trend followers, because of the historic diversification benefits.
But having decided to invest in CTA strategies, it is not unusual for investors to choose to allocate to only one or two managers. It is our observation that even experienced and savvy institutional investors frequently overlook the value of diversification when it comes to investing in managed futures. Some of the reasons for this approach include:
Performance of the largest trend-following managers must be similar since they are highly correlated.
It is not hard to predict which managers will perform well. The best-performing large CTAs will continue to outperform because they constantly invest in research to increase their edge in strategy development and execution.
The cost of underdiversification is low. Diversification may seem to be a good idea, but it yields little tangible benefit in the case of traditional trend followers.
While the above explanations are very intuitive, our research indicates that the empirical data demonstrates the value of diversification, even among trend followers.