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Adding Diversified Trend Following to Target-Date Funds

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Summary

The document examines how trend following could address the equity risk concentration in conventional target-date funds. Their glide paths reduce stock allocations as retirement approaches, yet the portfolio may remain dominated by equity risk, leaving savers exposed to large losses near retirement. The proposed approach reallocates some stock exposure to a diversified long-short strategy trading liquid futures and forwards across global equities, bonds, and currencies. It combines short- and long-term trend signals with a signal intended to identify trends that have become overextended, then sizes positions using volatility estimates, risk targets, and risk limits.

The authors describe historical evidence across 38 markets and report that trend following was profitable in eight of the ten worst drawdowns of a traditional 60/40 portfolio, with weaker results in two episodes. They also present a retirement-period analysis in which adding trend following reduced drawdowns and improved risk-adjusted outcomes. These findings come from historical analysis described by the source and do not establish future performance. Results depend on the strategy design and volatility target; sharp reversals and extended directionless reversals are cited as difficult conditions.

Key ideas

  • Traditional target-date portfolios can retain substantial equity risk even as their stock allocation declines.
  • Trend following can diversify stock and bond exposure by trading equities, fixed income, and currencies long and short.
  • The proposed design combines signals across multiple trend horizons and includes a measure of trend extension.
  • The strategy's reported drawdown protection was not consistent across all historical episodes, especially during sharp reversals.
  • The suggested allocation keeps trend-following exposure steady as a share of the target-date portfolio, funded from equities.

Tags

Trend followingMulti-assetRisk managementPortfolio constructionFutures

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.