In this note, we show that the buying and selling of any market by a trend-following strategy is driven by changes in three key complementary factors: its signal or trend-strength, its risk or volatility, and a “portfolio-scaling factor” that reflects adjustments due to the applied portfolio construction or risk management methodology. This portfolio-scaling factor is driven by changing cross-asset correlations (or more generally by the cross-signal correlations) and is used to actively manage the overall portfolio risk exposure.

We introduce a simple analytical formula that attributes the change in an instrument’s dollar exposure to the change in each of the three factors across time in a generic trend-following context. This approach allows us to identify and quantify the key drivers behind any noticeable increase or reduction in exposure to a single instrument, a group of instruments, an entire asset-class, or the full portfolio across time.

We take a closer look at the relative contribution of these three factors during the most recent period between January and March 2022, which has been characterized by a substantial expansion of trend opportunities, coupled with a sharp rise in volatilities across fixed-income and commodity markets.

Furthermore, we illustrate how changes in trend-signals, individual market volatilities, and the portfolio-scaling factor have each contributed to the overall portfolio turnover of a generic trend-following strategy since 2005.

We conclude this note by highlighting that in the long-run, changes in individual market trend- signals only account for little more than half, or on average 60%, of a typical trend-follower’s portfolio turnover. The remaining trading activity is driven by risk-management and portfolio construction. Over shorter periods, risk-management factors, e.g., driven by a sudden volatility spike or correlation shifts across one or more asset-classes, may even explain up to 80% of the turnover of a medium- to-long-term trend-following portfolio.