Those in DC drawdown are more exposed to sequence risk

Members who transfer their defined benefit pot or defined contribution members who opt for drawdown are more at risk of sequence risk, it has been claimed.

Speaking at a conference in London today, Cass Business School Professor of asset management Andrew Clare said it is a risk that is “very poorly understood” but it relates to the order in which returns from investments occur, rather than the average over time.

“The outcomes can be very devastating for some people and it’s really a matter of luck whether it affects you or not,” he said.

For example, he said sharp falls in markets, created by the economic and political background, can have a devastating effect on people drawing an income. Traditionally, a way of protecting investors from this would be to invest in safe assets, but index linked gilts currently have a negative yield.

He also said diversification, another option, did not help as much as it would have been liked in the global financial crisis. In addition, he noted the use of put options, which protect you from very sharp downfalls, but which are very expensive.

Therefore, he recommends using trend following, which is where you look at an asset class and if it is in a positive trend, you remain in it, but if it is in a negative trend then you come out and put the money in cash.

He said you define a positive trend by looking at the moving average of the index and if you are above it then you remain, if you are below it then put it in cash. “It’s a bit like what some of the trend following hedge funds do but there is no short selling.”

Speaking more broadly about geopolitical risks, Clare said there is a lot of uncertainty for the future both politically and economically. On President Trump, Clare noted his presidency so far has been “chaotic and embarrassing” and we could end up with a “Trump-introduced financial market meltdown” despite the markets reacting well so far.

However, he said following Trump, the West will be left with the longer term issue of how western democracy recovers from a Trump presidency. “What do we say to some dictator in some far off world about nepotism, embezzlement and enrichment when someone could say, Trump did it…it’s frankly disgraceful and unfortunately it is a disgrace that we as a western democracy will have to bear.”

On Brexit, Clare said it will be a “massive leap into the economic dark” as we do not know what may happen. He noted the two extremes, a no deal, or the UK remains in the single market. He believes both are unlikely to happen but a no deal is most likely out of the two.

He said over the next two years we are going to swing backwards and forwards from no deal to good deal. Clare also said, counter to the argument that nothing has happened since the referendum, sterling has fallen by about 15 per cent against major currencies, which he described as a “vote of no confidence” from the rest of the world.

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