Investors hate drawdowns. However, pretty much every attempt at shallower drawdowns comes with costs. Transaction costs and taxes aside, the biggest one is the opportunity cost of missing out on subsequent rallies after having avoided a deep drawdown.
While drawdowns are a very visible risk, the model risk of a strategy that tries to avoid them should not be discounted. The problems with drawdowns is that they are a rare beast compared to the generally upward trending nature of markets. This makes arriving at robust parameters pretty much impossible. Fragile models do not give a lot of confidence when they underperform market beta leading investors to abandon them just before a drawdown that they are designed to avoid comes calling.
However, these problems do not prevent academics from soldering on. Keller, Wouter J. and Keuning, Jan Willem, Breadth Momentum and Vigilant Asset Allocation (VAA): Winning More by Losing Less (July 14,
2017, SSRN) is one such attempt. A summary of the paper can be found here.
We reproduced it with listed ETFs and the results are sobering.
An in-sample hero but an out-of-sample dud.
No amount of behavioral reinforcements would have been enough to stick with this model when equity markets rallied after 2022.
Practically, investors are better off managing drawdowns through asset allocation (hence giving up the upside during booms) or through using simple trend-following to avoid steep drawdowns (hence incurring higher transaction costs due to whipsaws) than trying to construct a Rube Goldberg machine.
Code and charts on github.