5 Things Some Investors Get Wrong About Trend-Following - And Why It's Worth Rethinking Portfolio Resilience

Trend-following has been a cornerstone strategy for many sophisticated allocators over decades. Yet it remains surprisingly underrepresented in the portfolios of high-net-worth individuals and family offices. Why? Because common misconceptions often overshadow its proven benefits.

Below are five of the most frequent misunderstandings we hear from advisers and investors, and why it's worth taking a fresh look.

1. "Trend-following doesn't work anymore."

It's a refrain that pops up regularly: "Trend-following is dead." History tells a different story. During major market dislocations - such as 2008, 2014, 2020, and 2022 -- trend-following strategies have often been among the best performers.

The key is understanding that trend-following is cyclical, not broken. It thrives in volatile or directional markets, i.e. precisely when traditional portfolios, heavily reliant on equities and bonds, struggle.

2. "It's just chasing momentum."

This is a common oversimplification. Trend-following isn't about hype, news, or hot sectors. It's about price confirmation. Systematic, rules-based models scan global markets daily, adjusting exposures based solely on observable price trends.

This removes emotion and narrative bias from the equation, resulting in a disciplined process rather than a speculative bet.

3. "It's too volatile for wealth preservation."

Uncorrelated doesn't mean reckless. In fact, professional trend-following programs explicitly target and manage volatility.

More importantly, trend-following tends to be "long volatility", meaning it often gains when traditional assets fall sharply. This provides essential ballast in downturns, preserving capital when it matters most.

4. "It's only for commodity traders."

That was the perception decades ago, but today's trend-following strategies are far more diversified. They trade across equities, fixed income, currencies, and commodities, spanning global liquid markets.

These aren't directional commodity bets; they are dynamic, macro-driven strategies that adapt to evolving market regimes.

5. "It doesn't belong in a strategic allocation."

Some treat trend-following as purely tactical or opportunistic. The data challenges this view.

Over full market cycles, trend-following has delivered consistent positive returns, low correlation to traditional assets, and strong risk-adjusted performance -- especially in equity crises.

This makes it a powerful core diversifier for multi-asset portfolios focused on resilience.

Conclusion

At ECCM, we view trend-following not as speculation, but as a portfolio stabiliser.

It requires no forecasting or macro calls, just a robust, repeatable process to adapt as markets shift.

For investors seeking durable, long-term capital growth with reduced drawdowns, trend-following deserves serious consideration.

The volatility currently seen in bond markets is being fuelled by a combination of macroeconomic forces. In the U.S., ballooning fiscal deficits and a new $3.8 trillion tax bill are putting upward pressure on long-term interest rates. At the same time, foreign demand for U.S. Treasuries appears to be weakening. Central banks are reducing interest rates, yet are constrained in their influence over longer-dated bonds. Meanwhile, Australia faces a decade of projected deficits of its own, and our yield curve continues to respond more to global forces than domestic settings.

These pressures are driving significant steepening in the yield curve - the difference between short- and long-dated bond yields. Steepening curves allow skilled credit managers to adjust risk exposure and capitalize on price differences.

In this environment, extending the maturity of our bond holdings has become more appealing, particularly given longer-term bonds can offer stronger price gains as they approach maturity - a dynamic we term "rolldown." At the same time, we're also seeing anomalies in credit spreads, where less sophisticated investors are prioritising yield over relative value, creating pockets of possible mispricing. This is where active management proves its worth. Passive bond funds are bound by index rules. They cannot reposition for anticipated curve moves, nor can they selectively add risk when prices dislocate.

Given the Bloomberg FRN Index is more highly rated (average AA- compared to BBB) with shorter spread duration (~two years compared to ~three), the Yarra Higher Income Fund (HIF) is well placed to outperform during risk-on periods (refer Chart 1). However, HIF's outperformance during certain risk-off periods demonstrates the potential benefits of active management. HIF outperformed the index through 2022 in an environment of both higher bond yields and credit spreads and more recently in April 2025.

Outperformance in April provides a recent example of how nimble decision-making up and down the curve may contribute to risk adjusted returns. While the FRN Index posted a negative excess return of 11bps compared to the RBA Cash Rate, HIF posted a positive 32 bps excess return despite credit spreads widening by 20-30bps over the month.

In April, we started the month expecting volatility around geopolitical events, which prompted us to lift cash levels and position our portfolios with higher overall interest rate duration. Crucially, we also implemented this with a steepening bias or, in other words, a view that long-term interest rates would rise faster than short-term rates. By focusing our exposure on the front of the curve, or short-term bonds, and being underweight long-term bonds at the back end, we were well-positioned when the long end sold off sharply while the short end remained stable.

Chart 1 - Cumulative Return - Yarra Higher Income Fund v. Bloomberg FRN Index

Source: YCM/BBG, June 2025.

In terms of stock selection, April also presented some fantastic buying opportunities for us to take advantage of spread widening and add high-quality credit exposures at discounted levels. One such name was the USD-denominated Perenti 2029 bonds, an issuer we had previously sold at tight spreads of BBSW+180bps and were able to buy back ~200bps wider (BBSW+380bps). Credit spreads have since contracted ~100bps from these wides, providing a tidy return on investment.

While our portfolio positioning has not changed markedly from 12 months ago, these two recent examples show how we're actively managing nimble, benchmark-unaware portfolios that are more 'all-weather' credit in nature. Our April performance, in which both Yarra's Enhanced Income Fund (EIF) and Higher Income Fund (HIF) posted positive absolute returns, underscores the value of our approach. Our strategy came together as a result of preparation, speed, and conviction, none of which are available to passive strategies.

Looking beyond the tactical wins, and the case for active credit is supported by the broader macro context. While spread volatility continues, outright yields in the front and mid-parts of the curve have held steady. That means the income on offer remains attractive - and investors are simply being rewarded through a different mix of risk premia. The flexibility to shift between spread and rate risk allows us to preserve capital and position for growth, depending on where the market is offering best value.

It's a powerful setup. Investment-grade credit today is offering yields that, on a 12-month view, look comparable to long-term equity market returns - but without the same drawdown risk. Across the spectrum, private credit looks less compelling: the illiquidity and default risk required to justify allocations to private credit simply aren't being compensated in this environment.

Looking ahead, we see the drivers of this opportunity set - fiscal overreach, inflation variability, and steepening curves - as persistent features of the bond market over the next 6 to 12 months. We believe this is a sweet spot for credit investing. High running yields and steeper curves, allowing active positioning across durations are compelling and signal the era of 'buy everything and wait' in fixed income is over. Today's market rewards clarity of view, agility of execution, and a willingness to lean into volatility when others step back.

"The investor's chief problem -- and even his worst enemy -- is likely to be himself."
Benjamin Graham, 1949

Human beings are hardwired for survival, not for investing. The psychological traits that helped our ancestors survive in tribes and navigate danger now often hinder our ability to build long-term wealth. At Canopy, we believe managing our own behavioural biases is as fundamental to our investment process as our rigorous quality assessment or valuation discipline.

Buy high, sell low!

Investment returns and investor returns are not the same thing. Markets have historically rewarded patient capital, but most investors fail to capture these returns due to poor timing decisions, a phenomenon known as 'the behaviour gap'. It occurs because investors systematically buy after prices have already risen and sell after they have fallen, transforming market volatility from a potential opportunity into a source of loss. Understanding and defending against this dynamic is crucial for long-term wealth creation, as even small behavioural penalties compound dramatically over time.

^{Source: The Behaviour Gap, Carl Richards.}

This pattern has been consistently documented in studies of investor behaviour. As noted in Chapter 4, DALBAR's long-running analysis found that over the last three decades, the average US equity fund investor has underperformed the S&P 500 by 3-4% annually, primarily because of buying high and selling low during volatile periods (2022). Morningstar's Mind the Gap study (2023) has reached similar conclusions, finding that the average dollar invested in funds earned a 10-year return to December 2022 that was 1.7% less annually than the average underlying fund.

Perhaps the most striking example comes from one of history's most successful fund managers. Peter Lynch managed the Magellan Fund at Fidelity Investments between 1977 and 1990, producing an annualized return of 29.2%. Yet it has been reported that the average investor in his fund made only 7% per annum (Jakab, 2016). Despite having access to exceptional investment performance, poor timing decisions cost investors the majority of their potential returns.

The behaviour gap tends to be most pronounced during periods of market exuberance or stress, as illustrated in Figure 2. In the lead-up to the GFC in 2007, equity fund inflows remained strong despite mounting economic risks. As equity markets declined through 2008, fund outflows accelerated dramatically, reaching their most negative levels during 2008-2009. As it turned out, this was actually a great buying opportunity. Crucially, outflows continued even after markets began recovering, with flows remaining negative through 2011 despite substantial market gains during this period. This timing pattern illustrates how investor behaviour often lags market turning points, leading to suboptimal entry and exit decisions.

^{Source: Investment Company Institute, Canopy Investors.}

When instincts backfire

To cope with the daily information overload, our minds rely on mental shortcuts called heuristics. While these shortcuts serve us well in many aspects of life, they can also work against us. Several behavioural biases are particularly problematic for investing:

• Confirmation bias causes us to seek information that supports our existing beliefs while ignoring contradictory evidence. An investor convinced of a company's potential might focus on management's optimistic guidance while dismissing customer complaints, executive departures, or deteriorating financial metrics.
• Overconfidence tricks us into believing we can predict outcomes with greater certainty than we actually can. This might manifest as an investor who has enjoyed success with a few stock picks becoming convinced they can time market cycles, leading them to make increasingly concentrated bets or using leverage.
• Loss aversion makes losses feel more painful than equivalent gains feel pleasurable. This asymmetry leads to seemingly irrational behaviour: holding losing positions for too long (hoping to 'break even') while selling winners too quickly (to 'lock in gains').
• Hindsight bias convinces us we 'knew it all along' after events unfold, preventing us from learning from our mistakes. An investor might remember being 'cautious' about a failed investment when their notes actually show they were highly confident at the time of purchase, preventing honest post-mortems that could improve future decision-making.
• Groupthink emerges when teams prioritise harmony over critical thinking. Investment committees might reach consensus not because the analysis is sound, but because challenging the prevailing view feels uncomfortable.
• Recency bias leads us to overweight recent events when making decisions. Investors often chase last year's best-performing asset class assuming recent trends will continue indefinitely. This backwards-looking approach systematically buys high and sells low, as yesterday's winners often become tomorrow's laggards.
• Herding makes us feel comfortable following the crowd, even when the crowd is heading toward a cliff. The Dutch tulip mania, the South Sea Bubble, and the housing bubble all shared a common thread: rational people making irrational decisions because 'everyone else was doing it'.

^{Source: Tom Fishburne.}

These biases often work in combination, amplifying their individual effects. Recency bias might lead an investor to chase last year's hot sector, while confirmation bias ensures they only read bullish research, and overconfidence convinces them to make an oversized bet. When a reversal eventually comes, loss aversion prevents them from cutting losses quickly, and hindsight bias ensures they learn nothing from the experience.

Our approach

The late Nobel laureate Daniel Kahneman reached a somewhat disheartening conclusion at the end of his influential book 'Thinking, Fast and Slow': there is little we can do as individuals to prevent behavioural biases from influencing our decisions. He considered that objectivity is easier when evaluating others' decisions than our own; "it is much easier to identify a minefield when you observe others wandering into it than when you are about to do so."

At Canopy, we have adopted team and rules-based processes to minimise individual biases, with our flat structure serving as the foundation:

• Institutionalized dissent: We have deliberately built structured debate into our process, recognising that it is often easier to spot flaws in someone else's reasoning than in our own. Every position in the Fund has a 'secondary analyst' whose primary task is to act as devil's advocate to the primary analyst's view. This structure reduces the prospect of groupthink and confirmation bias by forcing alternative perspectives into every investment discussion.
• Independent conviction ratings: Each team member maintains independent views on stocks, and these views directly impact portfolio construction. Ratings and comments are recorded and reviewed when performing post-mortems on positions, increasing accountability among all team members, reducing hindsight bias, and accelerating learning from both successes and failures.
• Pre-mortem analysis: Before taking positions, we routinely perform pre-mortems, where we imagine our thesis is incorrect a couple of years into the future and consider what might have gone wrong. This exercise reduces groupthink, confirmation bias, and overconfidence by forcing us to actively consider how our thesis might be wrong.
• Multiple valuation approaches: We use several valuation methodologies to avoid the pitfalls of relying on simple multiples or heuristics alone. Additionally, our valuations are expressed as ranges rather than point estimates, helping to reduce overconfidence, and acknowledging the inherent uncertainty in any valuation exercise.
• Disciplined selling framework: To combat loss aversion, we maintain strict sell discipline. We are particularly vigilant about selling stocks where there has been material 'thesis creep' - gradual changes to our original investment rationale that often signal we are rationalising poor performance. In our experience, these situations frequently become value traps. For high-quality companies, we more gradually reduce positions when valuation becomes the primary concern.
• Variant perception: When investing in any stock, we work to identify our source of edge and how our view differs from the market consensus. Since markets are typically efficient, the best opportunities arise when we can disagree with the consensus while maintaining strong conviction in our analysis.
• Systematic position sizing: We use a systematic tool that translates our quality and valuation assessments into suggested portfolio weights. As illustrated in Figure 4, higher-quality companies are allocated a substantially larger position size for any given expected return.¹ As these weights change daily with share prices (and less frequently with our fundamental assessments), we are prompted to dispassionately evaluate position sizes, helping to reduce the influence of recency bias and emotion.
• Decision quality over outcomes: We seek to evaluate the quality of our decisions rather than judging success solely according to outcome. This distinction helps us learn from both wins and losses by focusing on whether our analysis was rigorous and our reasoning sound, rather than results that may reflect luck or short-term market movements.

^{Source: Canopy Investors.}

While no process can eliminate mistakes entirely, ours is designed to reduce the risk of material missteps and support more disciplined position sizing. We accept that we will make mistakes, but by identifying potential pitfalls before committing capital - not after - we improve our chances of avoiding them. The same behavioural traits that once helped humans survive can undermine investment decisions. Our process has been designed to help our portfolio succeed in spite of them.