Practical Applications of Skew and Trend Aversion: The Impact of Positive Skew and Behavioral Biases on Allocation Decisions

Practical Applications Summary

In Skew and Trend Aversions: The Impact of Positive Skew and Behavioral Biases on Allocation Decisions, from the Winter 2020 issue of The Journal of Alternative Investments, Zachary Dugan (International Standard Asset Management, Johns Hopkins University) and Alexander Greyserman (International Standard Asset Management) investigate potential reasons for small portfolio allocations to trend-following strategies that are observed in most portfolios. Trend-following strategies can deliver “crisis alpha,” which is a positive return when markets are down. Their returns are positively skewed with a low correlation with the S&P 500, but their average returns are close to the S&P 500. These characteristics indicate that most portfolios could benefit from a healthy allocation to this strategy. The authors explain that investors are particularly prone to behavioral biases when evaluating strategies that have positively skewed returns. By quantifying biases implied by suboptimal portfolio allocations to trend-following strategies, they expose commonly chosen poor allocation decisions so that the reader can avoid making suboptimal choices.