In this research note, we explore the relationship between trend-following CTA performance and the number of independent risk factors required to explain such performance. More specifically, we show that historically, trend-following CTA performance has been strongest when trends were primarily driven by only a few systemic global cross-asset risk factors, such as in 2022 (or 2008). Conversely, trend-following performance has been weaker when trends were driven by a wider range of market- specific or idiosyncratic risk factors, such as in 2023 (or 2018). In fact, 2023 stood out as a year unlike any other in the last 25 years, requiring more than 30 independent statistical risk factors to replicate the performance of a generic trend-following CTA approach simulated on a diversified investment universe of more than 100 instruments. In contrast, only 8 factors were required in 2022, the lowest number ever recorded for a given year, except for 2008, since the start of our analysis period in 2000.

More generally, we outline an inverse linear relationship between the number of independent risk factors and the resulting trend-following performance. The lower the identified number of risk factors is, the higher the recorded trend-following performance, as confirmed by the CTA industry performance in 2008 and 2022.

We conclude that investment universe diversification for a trend-following CTA becomes more important in less attractive market regimes governed by many different idiosyncratic risk factors. The larger and the more diversified the investment universe, the more likely a trend-following strategy is to successfully gain exposure to the many idiosyncratic, market-specific risk factors that drive profitable price trends. A trend-following program running on a more concentrated investment universe is likely to perform as well as a more diversified CTA in years with only a few strong macro risk factors. However, only a highly diversified investment universe can capture a higher number of idiosyncratic risk factors, providing an ability to outperform a more concentrated approach over the long run.