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

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  • Clare, Andrew
  • Seaton, James
  • Smith, Peter N.
  • Thomas, Stephen

Abstract

We examine applying a trend following methodology to global asset allocation between equities, bonds, commodities and real estate. This strategy offers substantial improvement in risk-adjusted performance compared to buy-and-hold portfolios and a superior method of asset allocation than risk parity. We believe the discipline of trend following overcomes many of the behavioural biases investors succumb to, such as regret and herding, and offers a solution to the inappropriate sequence of returns which can be problematic for decumulation portfolios. The other side of behavioural biases is that they may be exploited by investors: an example is momentum investing where herding leads to continuation of returns and has been identified across many assets. Momentum and trend following differ as the former is a relative concept and the latter absolute. Combining both can achieve the higher return levels associated with momentum portfolios with much reduced volatility and drawdowns due to trend following. Measures based on utility of a representative investor reinforce the superiority of combining trend following with momentum strategies. These techniques help address the sequencing of returns issue which can be a serious issue for financial planning.

Suggested Citation

  • Clare, Andrew & Seaton, James & Smith, Peter N. & Thomas, Stephen, 2016. "The trend is our friend: Risk parity, momentum and trend following in global asset allocation," Journal of Behavioral and Experimental Finance, Elsevier, vol. 9(C), pages 63-80.
    • Handle: RePEc:eee:beexfi:v:9:y:2016:i:c:p:63-80
    DOI: 10.1016/j.jbef.2016.01.002
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    Cited by:

    1. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2014. "European Equity Investing through the Financial Crisis: Can Risk Parity, Momentum or Trend Following Help to Reduce Tail Risk?," Discussion Papers 14/02, Department of Economics, University of York.
    2. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, March.
    3. Grebenkov, Denis S. & Serror, Jeremy, 2015. "Optimal allocation of trend following strategies," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 433(C), pages 107-125.
    4. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2016. "Reducing sequence risk using trend following investment strategies and the CAPE," Discussion Papers 16/11, Department of Economics, University of York.
    5. Denis S. Grebenkov & Jeremy Serror, 2014. "Optimal Allocation of Trend Following Strategies," Papers 1410.8409, arXiv.org.
    6. Zaremba, Adam & Szyszka, Adam & Long, Huaigang & Zawadka, Dariusz, 2020. "Business sentiment and the cross-section of global equity returns," Pacific-Basin Finance Journal, Elsevier, vol. 61(C).
    7. Andrew D. Clare & James Seaton & Peter N. Smith & Stephen H. Thomas, 2021. "Can sustainable withdrawal rates be enhanced by trend following?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(1), pages 27-41, January.
    8. Platanakis, Emmanouil & Sakkas, Athanasios & Sutcliffe, Charles, 2019. "Harmful diversification: Evidence from alternative investments," The British Accounting Review, Elsevier, vol. 51(1), pages 1-23.
    9. Hubert Dichtl, 2020. "Investing in the S&P 500 index: Can anything beat the buy‐and‐hold strategy?," Review of Financial Economics, John Wiley & Sons, vol. 38(2), pages 352-378, April.
    10. Sebastien Valeyre, 2022. "Optimal trend following portfolios," Papers 2201.06635, arXiv.org.
    11. Zaremba, Adam & Kizys, Renatas & Tzouvanas, Panagiotis & Aharon, David Y. & Demir, Ender, 2021. "The quest for multidimensional financial immunity to the COVID-19 pandemic: Evidence from international stock markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 71(C).
    12. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2015. "Size Matters: Tail Risk, Momentum and Trend Following in International Equity Portfolios," Discussion Papers 15/06, Department of Economics, University of York.
    13. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2017. "Decumulation, Sequencing Risk and the Safe Withdrawal Rate: Why the 4% Withdrawal Rule leaves Money on the Table," Discussion Papers 17/06, Department of Economics, University of York.
    14. Tzu-Pu Chang & Yu-Cheng Chang & Po-Ching Chou, 2022. "The Trend is Your Friend: A Note on An Ensemble Learning Approach to Finding It," Bulletin of Applied Economics, Risk Market Journals, vol. 9(1), pages 19-25.
    15. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2019. "The Rehabilitation of Glidepath Investing," Discussion Papers 19/17, Department of Economics, University of York.
    16. Adam Zaremba, 2019. "The Cross Section of Country Equity Returns: A Review of Empirical Literature," JRFM, MDPI, vol. 12(4), pages 1-26, October.
    17. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2014. "When Growth Beats Value: Removing Tail Risk From Global Equity Momentum Strategies," Discussion Papers 14/09, Department of Economics, University of York.

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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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