A financial veteran has built an investment model which aims to prevent withdrawals from eating into investors' cash, as he warns of the pitfalls of trying to predict markets.
Andrew Clare, chair in asset management at Cass Business School, said he thought the financial industry had let down retail investors over the past few years.
He pointed to what he described as the “old fashioned” approach, where pension funds are mechanically de-risked into gilts when a client reaches the age of 55, and then moved into an annuity at the age of 65.
Mr Clare said these traditional solutions have been unable to prevent withdrawals from significantly eroding capital values, even when money is being pulled from a fund at a very low rate.
Speaking at an event hosted by the business school and Raymond James Investment Services, Mr Clare said his model attempts to smooth returns and therefore mitigate against sequence risk.
Sequence risk refers to the danger of retirees running out of money early by withdrawing income from their invested savings when market returns are either low or falling.
Mr Clare’s model does not rely on forecasting, but instead it splits an investment equally into 10 asset classes with a “trend following” overlay, meaning the money is only allocated to an asset if the index value has been trending upward over 10 months.
However, this also means if one of the 10 per cent chunks is falling over 10 months then it is switched into a 'riskless' asset like cash.
The professor described this as an “on-off switch” and said it means investors can exploit behavioural biases in the market place.
The former economist at Legal & General Investment Management also claimed this process cuts off the tail risk which a client in retirement cannot afford to take, particularly during decumulation.
Mr Clare, who previously worked as a research manager at the Bank of England, said sequence risk is not considered “at all” in most classic financial textbooks.
This sequence of returns, he said, matters dramatically when investors are withdrawing from their pots.
“We essentially pay active managers to predict the future, but the problem is there are not many people who are very good at forecasting, and even highly trained economists get it wrong.”
He said the problem is forecasting is very difficult, which is why his model is not dependent on making predictions.
In each of the experiments conducted on this process, Mr Clare said his model scooped up a return which at least matched the performance of a passive investment.
Yet he pointed out that this process means there is no need for advisers to de-risk clients’ investment, even if the client is in retirement.
“We are still in asset classes that are risky but we are protecting against the downside.”