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The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation

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

Abstract

We examine the effectiveness of applying a trend following methodology to global asset allocation between equities, bonds, commodities and real estate. The application of trend following offers a substantial improvement in risk-adjusted performance compared to traditional buy-and-hold portfolios. We also find it to be a superior method of asset allocation than risk parity. Momentum and trend following have often been used interchangeably although the former is a relative concept and the latter absolute. By combining the two we find that one can achieve the higher return levels associated with momentum portfolios but with much reduced volatility and drawdowns due to trend following. We observe that a flexible asset allocation strategy that allocates capital to the best performing instruments irrespective of asset class enhances this further.

Suggested Citation

  • Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2012. "The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation," Discussion Papers 12/25, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:12/25
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    Cited by:

    1. 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.
    2. 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.
    3. 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.
    4. Sebastien Valeyre, 2022. "Optimal trend following portfolios," Papers 2201.06635, arXiv.org.
    5. 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).
    6. Platanakis, Emmanouil & Sakkas, Athanasios & Sutcliffe, Charles, 2019. "Harmful diversification: Evidence from alternative investments," The British Accounting Review, Elsevier, vol. 51(1), pages 1-23.
    7. 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?," CAMA Working Papers 2014-08, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    8. Adam Zaremba, 2019. "The Cross Section of Country Equity Returns: A Review of Empirical Literature," JRFM, MDPI, vol. 12(4), pages 1-26, October.
    9. Denis S. Grebenkov & Jeremy Serror, 2014. "Optimal Allocation of Trend Following Strategies," Papers 1410.8409, arXiv.org.
    10. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, February.
    11. 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.
    12. 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.
    13. 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.
    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. 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).
    16. 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.
    17. 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.

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    More about this item

    Keywords

    Risk parity; trend following; momentum; global asset allocation; equities; bonds; commodities; real estate;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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