TIP308: Trend Following Investing w/ Niels Kaastrup-Larsen (Business Podcast)

Episode Summary

Executive Summary: Niels Kostrup Larson explains trend following as a rules-based, diversified, and emotionally disciplined strategy that seeks to capture major market moves across many futures markets. He argues its edge comes from adaptive risk management, not prediction, and that its value is strongest as a long-term uncorrelated portfolio diversifier—especially when markets, correlations, or interest-rate regimes change.

Main Topics: Richard Dennis and the Turtle story (Priority: 5/5): Niels recounts Richard Dennis’s legendary trading career and the Turtle experiment to illustrate that trend following can be taught through rules rather than innate talent. Rules-based system design and evolution (Priority: 5/5): He explains that strong trend-following firms rarely change core rules, but do refine sizing, risk controls, exits, and timeframes when meaningful research breakthroughs appear. Trend following as portfolio diversification (Priority: 5/5): Trend following is framed as an uncorrelated return stream that can complement stocks and bonds, with diversification across asset classes being essential for effectiveness. Risk management and adaptive position sizing (Priority: 5/5): The conversation emphasizes that identifying trends is easier than managing exposure, and that improving risk control and exits is central to better risk-adjusted returns. Crisis alpha and performance across market regimes (Priority: 4/5): Niels argues that trend following has performed well in major crises and can benefit from both rising and falling rates, though results depend heavily on the crisis type. Behavioral biases and emotional discipline (Priority: 4/5): He stresses that human instincts—overconfidence, loss aversion, impatience, and attention bias—work against investors, making rules-based systems superior to discretionary trading.

Key Arguments: Trend following can be taught: Richard Dennis’s Turtle experiment showed that simple rules and discipline can produce strong results without special pedigree. The best trend followers do not tinker constantly; they preserve a stable core process and change only when research reveals major improvements. In trend following, the hardest part is not identifying trends but sizing positions, managing risk, and exiting when trends reverse. Diversification across many unrelated markets is critical; trend following on a single market or sector is not enough. Non-correlation matters more than raw return in portfolio construction; a lower-return asset can be superior if it is truly uncorrelated. Trend following is not the same as a hedge: it is an uncorrelated return stream that may sometimes correlate positively or negatively with equities. Commodity markets have historically been especially important during crises, often contributing the most consistent crisis-period trend returns. Trend following can work in rising interest-rate environments because it can go long or short, and Dun Capital has lived through such regimes historically. Behavioral mistakes are a major source of investor underperformance; systematic rules help remove emotion, ego, and reactionary decision-making.

Data Points: Richard Dennis trading success: a few thousand dollars to $200 million - Describing Dennis’s legendary futures-trading record in the 1970s and 1980s Dun Capital founding year: 1974 - Firm’s history as one of the oldest trend-following managers Major strategy changes: 3 or 4 - Niels says the firm made only a few major systematic changes over decades Time with no major changes: 1974 to about 2006 - Period when the firm kept its trend-following system largely intact Correlation to S&P: -0.05 - Reported long-run correlation of Dun Capital to the S&P, described as essentially zero Improvement frequency in strategy: 2006 and 2013 - Two major improvement points mentioned in the track record Track-record periods compared: 35-year, 14-year, and 7-year periods - He says annualized returns were nearly identical across these spans Interest-rate rise period: 1976 to 1981 - Historical regime in which the firm traded successfully during rising rates Stocks/bonds positive correlation frequency: around 66% - He claims stocks and bonds were positively correlated more often than not over more than 50 years Typical stock return / drawdown profile: 8% return with 50%+ drawdowns - Used to contrast stocks with more robust diversification alternatives Crisis periods cited: 1987, 2000, 2008, 2020 - Black Monday, tech bubble, global financial crisis, and COVID-19 Duration of February 2018 sell-off: 12 days - Example of a very short crisis-like move that was difficult for trend followers Client allocation example: 2% or 3% - He notes that small allocations to trend following are often too small to matter Best lookback period examples: 20 days, 40 days, 260 days - Illustrates how optimal trend timeframes can vary dramatically year to year Largest Apple exposure cited for Buffett: 43% - Used to illustrate the tradeoff between diversification and conviction Investor study result: best accounts were often forgotten or deceased - Fidelity study referenced to illustrate the value of low activity and patience CTA and 60/40 context: stocks and bonds have often been positively correlated historically - Argues 60/40 may lose diversification power if correlations normalize

Pivotal Quotes: "The seduction of safety is often more dangerous than the perception of uncertainty." — Niels Kostrup Larson: On why investors often prefer smooth returns even when they are less trustworthy or less effective over time "Trade what you test and test what you trade. There's no in-between." — Niels Kostrup Larson: On keeping systematic models free of discretion and preserving the integrity of research/backtests "We are not a hedge. We're an uncorrelated return stream." — Niels Kostrup Larson: Clarifying the difference between true negative correlation and trend following's long-run diversification role

Implications: Trend following is best viewed as a disciplined, long-horizon portfolio diversifier—not a market-timing shortcut. Investors should prioritize rules, risk control, and meaningful allocation size, and expect value from uncorrelated behavior across regimes rather than constant outperformance.