This made me wonder - has anyone studied whether trend following techniques may dampen sequence of returns risk and, thereby, produce higher safe withdrawal rates? I began running some numbers myself and it appeared that the application of a trend following technique may yield higher SWRs and then I stumbled across a recent paper titled "Reducing Sequence Risk Using Trend Following and the CAPE Ratio" by Clare et al (link below). In their paper, the authors conclude:
All this said, it's difficult to determine whether this strategy will be effective in the future given:The risk of experiencing bad investment outcomes at the wrong time, or sequence risk, is a poorly understood, but crucial aspect of the risk faced by investors, in particular those in the decumulation phase of their savings journey, typically over the period of retirement financed by a defined contributions pension scheme. Using US equity return data from 1872-2014 we show how this risk can be significantly reduced by applying trend-following investment strategies. We also demonstrate that knowledge of a valuation ratio such as the CAPE ratio at the beginning of a decumulation period is useful for enhancing sustainable investment income.
- Often, strategies lose their effectiveness once observed.
- Historically, it would have required significantly more effort and cost to employ a trend following strategy, heightening the observed historical premium of the strategy. In the current age of low expense ratios, ETFs, and limited (or no) commissions, what barriers exist? The strategy now just requires a process and the will to follow it.
- To some, trend following is synonymous with voodoo or tarot cards - that is, there is no rational explanation for it and no expectation that it will persist in the future. The underpinnings of this strategy are rooted in behavioral finance, so what if investors change their behavior?
What do you think?
Transcript of Meb Faber podcast: http://mebfaber.com/2017/12/13/episode- ... llocation/
Link to "Reducing Sequence Risk Using Trend Following and the CAPE Ratio": https://papers.ssrn.com/sol3/papers.cfm ... id=2764933