The issue
Sequence risk - the danger that the value of your investments will fall just before you need to start cashing them in - is an underappreciated but significant risk. It’s of particular concern to people entering retirement.
With the shift to defined-contribution pension schemes, savers must put serious thought into the timing and rate at which they draw on their pension funds. If they are not aware of this particular form of risk, they may lose out on income.
The research
Trend-following is an investment strategy which attempts to take advantage of long, medium or short-term moves observed in various markets. Research conducted by Professor Peter N Smith, along with colleagues at The Business School, City University, explored how sequence risk can be significantly reduced by applying this strategy to retirement funds.
Peter and his colleagues showed that, in some circumstances, individuals can expect to withdraw about 50% more per annum where trend-following strategies are used. The research also showed that income from pension savings can be improved by extracting information from market data such as the cyclically-adjusted price-to-earnings (CAPE) ratio.
The research demonstrated that investment in trend-following equities can raise expected returns significantly with no increase in overall risk, and with a reduced exposure to the specific risk of a large drawdown in wealth. The strategy was more effective than the typical advice, which is to ‘spread your eggs over many baskets’, diversifying your investment into a wider range of assets.
The outcome
The findings of the research have been widely disseminated, read and appreciated within industry circles. The investment strategy has already been implemented in four retail investment funds.
The 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.
