The brokerage industry as a whole is starting to question long-held beliefs. The following excerpt arrived from former Legg Mason chief market strategist on October 11, 2004:
For investors willing to engage in some insightful discussion of their core investment philosophy, the book will challenge long-held beliefs. Perhaps the most controversial argument is that Wall Street’s great effort of analysis and projections of the future are of little or no use to the serious investor. According to Covel, if the objective is to have a defined strategy to put capital to work for a profit, then investors are traders and the difference is more than a parsing of semantics. Trend Following is not an endorsement of day-trading and technical analysis. The basic premise is that the most profit is gained when a trader is harmonized to an enduring trend. To do this, traders need to adopt a strict discipline that minimizes behavioral bias (i.e., intuitive or ‘gut’ feel), does not anticipate a trend beginning or end, and acts when the trend changes. This approach is diametrically opposed to long-term ‘buy and hold’, which is viewed as a strategy that is best suited for passive indexing…Investment books that have a lasting appeal offer insight that resonates with a large number of investors. We believe Michael Covel’s Trend Following will be such a book. Importantly, Covel makes the case that investors are likely to benefit from having a portion of their portfolio invested in a non-traditional approach that adapts to whatever stock or asset class is exhibiting definable trends. While this ‘trader’ mentality may strike some as inappropriate, this approach is becoming modus operandi for some of the most sophisticated and successful long-term investors.
For more information on Legg Mason commentary please contact Legg Mason directly.
The significance of this commentary is not the endorsement of a single book. It is the source. A chief market strategist at one of Wall Street’s major brokerages, writing in 2004, is questioning whether the analytical and forecasting apparatus that justifies the brokerage industry’s existence produces anything of value for the serious investor. The statement that “Wall Street’s great effort of analysis and projections of the future are of little or no use” is not a fringe critique. It is an insider acknowledgment, coming from within the institution being critiqued.
The specific description of trend following’s requirements is worth examining carefully: strict discipline that minimizes behavioral bias, does not anticipate a trend beginning or end, and acts when the trend changes. These three requirements capture the complete psychological and operational difference between systematic trend following and every discretionary approach the brokerage industry promotes. Minimizing behavioral bias means rules override gut feel at the moment of decision. Not anticipating means no predictions, no forecasts, no price targets. Acting when the trend changes means reactive entry and exit, not predictive positioning. The Legg Mason strategist has described the approach more precisely than many practitioners do.
The portfolio diversification framing in the final sentence is also notable. A portion of a portfolio invested in a non-traditional approach that adapts to whatever asset class is exhibiting definable trends provides the uncorrelated return stream that adds genuine diversification value. A portfolio that is 100% traditional long-only equity is exposed fully to equity market risk. A portfolio that includes a systematic trend following allocation reduces that exposure and adds a component that historically performs well when traditional assets decline most severely. This is not a speculative addition to a portfolio. For sophisticated long-term investors, it has become standard practice.
Frequently Asked Questions
Why is the Legg Mason commentary significant?
Because it comes from within the brokerage industry and questions the value of the analytical and forecasting work that justifies the industry’s existence. A chief market strategist at a major Wall Street brokerage acknowledging that projections of the future are of little use to serious investors is an unusual and candid admission. It reflects the growing body of evidence that fundamental analysis and forecasting do not produce consistent investment advantages.
How does the Legg Mason description define trend following?
As an approach requiring strict discipline to minimize behavioral bias, no anticipation of trend beginnings or endings, and reactive action when trends change. This is a precise description of what systematic trend following actually requires. It distinguishes the approach from both discretionary trading and from passive indexing, positioning it as a third option that adapts to whatever market conditions are present.
Why should investors consider adding trend following to a traditional portfolio?
Because trend following’s returns have historically been uncorrelated with traditional equity and bond markets, and have often been positive during periods when those markets experienced the largest declines. A non-traditional allocation that adapts to whatever asset class is exhibiting definable trends provides diversification that a portfolio of correlated traditional assets cannot provide internally.
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