The TurtleTrader web site mentions numerous traders, most of whom trade a trend following system. However, to make money for yourself in trend following is different from trend following to make money off fees from clients. This is critical to understand. If the only thing you do is trend follow as originally intended, (to make the most money possible) then you align yourself with the turtles and what they learned.
The turtles were turned loose and told to make the most money possible. They had no restrictions. However, later on, when many of them went out to manage money for clients they changed some aspects of how they traded. They still continued to make a lot of money, but they also began listening to their clients. Why? Because managing money for others often puts you at their whims, and clients are always risk averse. By requesting less risky actions of the manager, the client puts a straight jacket on the manager from properly implementing the trading system.
Why do some managers handle client money if they know they will not be able to implement their system properly? Greed. Management fees from clients can be huge. If you manage $100 million you can get a 2-6% management fee even if there is no positive performance. That’s $2-6 million profit for being no more than a caretaker of assets. If you go this direction, you no longer are focused on trend following, you’re focused on the fee.
Issues to keep in mind:
- Clients seldom understand. Managing money for clients is hard. Clients usually don’t understand trend following and will often panic and pull out just before a big move that could make them a lot of money.
- Clients are impatient. They often put money with a manager at the wrong time and just as often take it away at the wrong time.
- Clients may request an initial system adjustment. They want trend following changed in order for them to invest their money in the first place. The manager is then faced with a difficult decision: take the client money and make money through management fees (which can be very lucrative) or trade as originally designed. Obviously, trading a trend following system as originally designed is the optimal path in the long run.
- More client money doesn’t mean more success. Trying to trade millions upon millions of dollars for clients is hard to do. Trend followers always had their best returns managing less money.
You can see why looking at publicly tracked money managers for clues to trend following reveals only half the story. If you let those statistics influence your assessment of trend following, you make a big mistake. The next time a money manager retires, look closely to see why. Usually difficult clients were the main reason.
What does all this mean for the individual trader?
Opportunity. The opportunity to make big money (30-100%), while trading as a trend follower, has never been greater as long as you:
- Trade a trend following system.
- Trade it the right way as intended.
- If you ever get to the point where you want to trade for others — never ever listen to their advice on how to trade the system.
The Institutional Constraint Problem in More Detail
The management fee structure described above creates a specific and well-documented misalignment of incentives. A manager with $100 million under management earns $2-6 million annually in management fees regardless of performance. The 20% performance fee that would be earned on strong returns requires producing those returns first. The management fee requires only retaining the assets under management. Retaining assets requires keeping clients satisfied. Clients are satisfied by smooth returns and low volatility, not by the lumpy distribution that optimal trend following produces.
This creates pressure on the systematic manager to modify their approach in the direction of smoothness rather than optimality. The trailing stop that would have caught a major move is widened to reduce short-term volatility. The position size that the system calls for is reduced because a large loss in an account the client is watching closely will trigger a redemption call. The markets that would diversify the portfolio but that clients find confusing are dropped to simplify the investor presentation. None of these modifications improve the system’s long-run expected returns. All of them improve the manager’s short-run asset retention.
This is why Jerry Parker’s statement is so clarifying: “Who wants a system like we have, 40% winners, losing money almost all the time, always in a drawdown, making money on about 10% of your trades?” Parker is describing what optimal trend following looks like from the client’s perspective. It looks terrible. The manager who trades it purely for their own account, where there is no client to satisfy and no management fee to protect, can follow the system exactly as designed. The manager who trades it for clients who will redeem at the first extended drawdown must choose between the fee income and the system integrity.
The point about best returns managing less money is documented in the track records of trend following managers who closed funds to new capital. Many of the highest-performing trend following managers either closed to new investors or maintained small funds specifically because capacity constraints reduce returns. Large pools of capital cannot enter and exit positions at the same speed as small ones. The slippage on large orders in less liquid markets erodes the edge. The manager who pursues maximum assets under management for fee income is explicitly choosing fee income over performance, because the two are in direct tension at large scale.
Frequently Asked Questions
Why do clients consistently pull money from trend following managers at the wrong time?
Because clients evaluate trend following performance against the wrong benchmark and over the wrong time horizon. When a trend following account is in a six-month drawdown, the client compares it to a stock portfolio that may have risen during the same period and concludes the trend following approach is failing. In reality, the drawdown may be perfectly consistent with the system’s expected probability distribution. The client who redeems during the drawdown misses the recovery that the system is designed to produce when trends materialize. This pattern of buying high and selling low is the main reason client returns are typically lower than the fund’s reported returns.
What is the conflict between management fees and optimal system trading?
Optimal trend following produces lumpy, volatile returns with extended flat and losing periods followed by large gains. Client retention requires smooth, consistent returns with limited drawdowns. The management fee is paid on assets retained, so keeping clients requires producing returns that satisfy them. This creates structural pressure to modify the system toward smoothness, which reduces the lumpy large gains that produce optimal long-run compounding. The manager optimizing for fee income produces a different system than the manager optimizing for returns.
Why do trend followers produce their best returns managing less money?
Because position entry and exit costs increase with position size. A systematic signal in a moderately liquid futures market can be implemented at minimal cost with a small position and at substantial cost with a large one. Large orders move the market against the trader. The edge available to a $10 million account trading the same signal is larger than the edge available to a $1 billion account, because the $1 billion account’s execution impact reduces the realized entry and exit prices. The manager who grows assets under management beyond the strategy’s capacity is explicitly accepting lower returns in exchange for higher fee income.
Trend Following Systems
Want to learn more and start trading trend following systems? Start here.
