Mitigating sequence risk with trend following investment strategies, for improved retirement outcomes

Drawing on a series of their research, Cass Business School academics have designed an investment strategy that could improve the retirement experience for many by mitigating an oft-neglected form of risk.

The form of risk in question is known as Sequence Risk. It is the danger that the timing of withdrawals from an account will have a negative effect on the overall rate of return. With the shift to defined-contribution pension schemes, savers must pay close attention to the timing and rate which they draw on their funds in retirement. If they are not aware of this particular form of risk, they may incur losses to their retirement income that are impossible to recoup.

Research carried out by Prof. Peter N. Smith of the University of York with Prof. Andrew Clare and Prof. Stephen Thomas, both of Cass Business School, demonstrates how this risk can be significantly reduced with the application of trend-following or smoothing investment strategies.

These are not new strategies by any stretch but their use in mitigating sequence risk is novel.

In a series of research papers, the authors demonstrate how these strategies can alleviate the effects of large falls in asset prices on both the accumulated value of savings, and also the amount individuals can withdraw throughout their retirement. In some scenarios, individuals can expect to withdraw around 50% more per annum then if they had adopted more conventional retirement portfolios.

The trend following approach may also significantly reduce the maximum loss experienced by the investment portfolio compared to those experienced by investors applying conventional strategies.

This investment strategy has already been implemented in four retail investment funds, and its authors are working with industry experts to make the research results available via a simple web-based tool. This project has attracted interest from Venture Capital investors with a view to market it in the UK and beyond.

The research papers that underpin this work are listed below and are all available for download or by request at City Research Online. The research has been presented at a number of presitigious industry conferences, and has generated great interest in the retirement investment community globally.

1. Trend following, risk parity and momentum in commodity futures

2. The trend is our friend: Risk parity, momentum and trend following in global asset allocation

3. Reducing sequence risk using trend following and the CAPE ratio

4. Can Sustainable Withdrawal Rates Be Enhanced by Trend Following?