In this note, using historical industry performance data since 2000, we argue that part of the performance of trend- following CTAs comes from an intrinsic ability to time equity market risk. We show that allowing for an unconstrained long allocation to equities is (1) key to capturing the full extent of this ability and (2) does not run counter to its risk mitigation properties.

We first show, based on an equity regime conditional attribution analysis of historical quarterly returns, that trend-following CTAs have provided significant equity risk mitigation over the past two and a half decades. Since 2000, we estimate that two thirds of the trend-following CTA industry’s total return have been generated during the 16 worst calendar quarters for equity markets, while the remaining 81 quarters have only accounted for the remaining one third. Moreover, trend-following CTAs have not only been uncorrelated with global equity markets over the long term, but have also delivered negatively correlated positive returns during the worst equity market periods and positively correlated positive returns outside of crisis periods.

Based on a univariate decomposition of trend-following returns into an alpha and an equity beta component, we further show that since 2000, more than 80% of the total trend-following performance can be attributed to (positive or negative) equity beta, which made a positive contribution in 70 out of 97 quarters during this period. In particular, we argue that negative crisis beta is a non-negligible source of risk mitigation benefits during periods of equity market stress. The contribution of negative crisis beta was positive in 15 of the 16 worst equity market quarters since 2000, accounting for more than 40% of trend-following CTA performance in these periods. Thus, the consistently positive return contribution of equity beta reported for all equity market regimes highlights a significant equity market timing ability of trend-following over the past 25 years.

Finally, based on three different approaches, we estimate that restricting a trend follower's long equity exposure is likely to be associated with a 20-30% reduction in long- term total performance, corresponding to 1.5% to 1.9% lower annualized excess returns. The benefits of such restrictions in terms of enhanced equity risk mitigation are limited: we show that the annualized performance contribution of trend-following in crisis periods could have been improved by up to +0.5% per year in the best case. We conclude that the long-term benefits of an unconstrained trend-following approach far outweigh any potential, but short-lived, benefits of limiting equity exposure to protect against market drawdowns. The long- term opportunity cost of restricting long equity exposures, regardless of the methodology employed, appears too high to compensate for the marginal improvement in risk mitigation during the occasional sharp corrections in equity markets.