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Same Roots Different Fruits

Posted on January 16, 2018

“You can have more than one home. You can carry your roots with you and decide where they grow.” – Henning Mankell

2018-01-16_diversity.jpgWhen we first launched Season Investments close to seven years ago, there were very few investment options with a trend following discipline being offered to the general public. In response we developed our own trend following model called MarketVANE. Our model has gone through a variety of small iterations and tweaks along the way, but it has always remained rooted in the trend following discipline based on our belief that over full market cycles trend following not only generates the best risk-adjusted returns but also minimizes the cost of being human by taking emotions out of the investment process.

The past seven years hasn’t been the best market environment for a trend following as stocks have steadily marched upward with little to no need for any sort of risk management discipline. Sure there were a couple isolated incidences like the summer of 2011 and the first quarter of 2016 where trend following strategies like MarketVANE really shined, but these have been the exception rather than the rule. In fact, pretty much any kind of risk management discipline including trend following, option writing, or even broad diversification has come at a cost to simply holding US large cap stocks.

The “cost” of trend-following in the form of lagging a buy-and-hold strategy during a bull market comes from what trend followers call “head fakes.” A head fake is simply a buy or a sell signal that doesn’t end up adding value. Trend followers have to be willing to lose small on all the head fakes in hopes that they will eventually win big on the signals that actually do add value (e.g. protect capital in a down market). As David wrote a couple years back in The Babe Ruth Effect, trend following is all about slugging percentage rather than batting average.

That being said, there are still ways to minimize the impact of head fakes during rampant bull markets while still remaining committed to having a trend following discipline in place. The best way to accomplish this goal is to simply diversify amongst a variety of trend following strategies. When you hold a basket of stocks, such as an S&P 500 index fund, you diversify away the idiosyncratic risk of holding a single stock and you are left with simply market risk. In a similar fashion, by holding multiple trend following investments, you can diversify away some of the head fake risk and be left with purer momentum based returns.

We started this post by stating that there were very few trend following investment options available to the general public when we launched our firm in 2011. Today, the story is much different as there a number of different trend following funds in either ETF or mutual fund offerings. We spent the past several months researching and vetting a number of these funds and have found three different options which we believe not only align with our core discipline but also provide a diversification benefit to MarketVANE.

As an example, the worst head fake we’ve experienced in our MarketVANE Stocks model was in the summer/fall of 2015. During this time, the market sold off and volatility spiked. In fact, the change in volatility (the volatility of volatility if you will) was so great that it surpassed the levels experienced during the Global Financial Crisis. After an 8%-10% move down in our model, MarketVANE gave us a sell signal and we moved to cash in September only to miss out on an 8% rebound in the market during the month of October. MarketVANE Stocks then flipped back to being partially invested in November and December which were both moderately negative return months.


The chart above shows the returns over this five month period for the MSCI All Country World Index (ACWI), MarketVANE Stocks, and a theoretical trend following blend of 25% to MV Stocks and each of the three aforementioned trend following funds. Now as a disclaimer, we are using a mix of real money, live model, and back tested results for this exercise, but the conclusion is that the blend ends up outperforming MarketVANE because not all the trend following disciplines are relying on the same buy/sell signals. This results in a shallower drawdown during the first two sell-off months and a slight uptick in October 2018-01-16_stats.PNGwhen the market came roaring back. The blend still underperformed our buy-and-hold benchmark, but that is to be expected in any sort of rapid reversal scenario.

In fact, when we use back tested results to model theoretical returns over the past 2 decades, the blend of trend following managers outperforms MarketVANE as a stand-alone through multiple market environments by delivering better absolute returns with lower volatility and/or drawdown risk.

In summary, although we are very proud of MarketVANE and the work we’ve put into building it, we still realize that value can be gained by holding different fruits with the same roots. We are remaining true to our commitment to risk management through trend following (e.g. roots) while expanding the toolbox (e.g. fruits) to accomplish this goal. 

elliott_headshot_bw.jpgAuthor Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.

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Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.