Reducing Sequence Risk Using Trend Following and the CAPE Ratio

Financial Analysts Journal
September 2017 | Vol. 73 | No. 4 | 13 pages
Source: CFA Institute
Andrew Clare James Seaton Peter N. Smith Stephen Thomas

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Summary

The risk of experiencing bad investment outcomes at the wrong time, or sequence risk, is a poorly understood but crucial aspect of the risk investors face—particularly those in the decumulation phase of their savings journey, typically over the period of retirement financed by a defined contribution pension scheme. Using US equity return data for 1872–2014, we show how this risk can be significantly reduced by applying trend-following investment strategies. We also show that knowing a valuation ratio, such as the cyclically adjusted price-to-earnings (CAPE) ratio, at the beginning of a decumulation period is useful for enhancing sustainable investment income.

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