Momentum Strategies in Futures Markets and Trend-following Funds

In this paper we rigorously establish a relationship between time-series momentum strategies in futures markets and commodity trading advisors (CTAs), a subgroup of the hedge fund universe that has grown to USD 300 billion and has attracted a lot of attention during the financial crisis. Building on this relationship, we carry out the first rigorous test of the hypothesis that capacity constraints exist in trend-following investing. Using a cross-section of 71 futures contracts over the period 1974-2012, we first construct one of the most comprehensive sets of time-series momentum portfolios across various trading frequencies. Second, we provide evidence that CTAs follow time-series momentum strategies, by showing that such benchmark strategies have high explanatory power in the time-series of CTA returns. Third, based on this result, we investigate whether there exist capacity constraints in time-series momentum strategies. Consistent with the view that futures markets are relatively liquid, we do not find evidence of statistically significant capacity constraints when using two different methodologies and several robustness tests. Our results have important implications for hedge fund studies and investors. Motivated by the fact that CTA funds differ in their forecast horizons and trading activity (e.g. Hayes 2011) we extend the work of Moskowitz, Ooi and Pedersen (2012) and evaluate time-series momentum strategies in futures markets over a broad grid of lookback periods, investment horizons and frequencies of portfolio rebalancing. We find strong time-series momentum patterns in monthly, weekly