Diversification is the primary tool for increasing portfolios’ Sharpe ratio (a metric for risk-adjusted return which shows excess return per unit of risk). Almost all clients we work with have portfolios that incorporate equities, credit, bonds, private markets and alternative assets including commodities, real estate and hedge funds. Since these assets aren’t perfectly correlated, incorporating them in a mix will boost the expected Sharpe ratio of the portfolio. So far, so good.

But here’s the problem: many of these assets have similar underlying return drivers. Consider stocks, credit, real estate and private equity, all of which rely on a growing economy for price appreciation. When this driver breaks down in a recession or other market event, these assets can sell off together. Diversification fails when investors need it most.

This is where trend following comes in. Unlike traditional assets, trend following does not rely on economic growth to generate returns and has historically been uncorrelated to equities, bonds, real estate and other asset classes.

Read | A Trend Following Deep Dive

Man Group

London-based Man Group is a technology-empowered active investor across equity, credit, commodities and currency markets, with a firm focus on delivering performance and client portfolio solutions.

Information provided is general information and is for educational purposes only, and does not include, or constitute as, financial product advice.