Should investors try to time their exposure to different factors? Factor-based strategies have become increasingly popular in recent years. But how to implement them in practice still remains a puzzle for many newcomers. Deciding whether to tactically monitor and adjust exposures to different factors and, if so, how to go about it, is often raised as a major concern.
In recent years, the growing awareness regarding the benefits of strategic allocation to a number of well-rewarded factors has led increasing numbers of investors to consider this option. But while single factor-tilted portfolios have proven they can significantly outperform the market over the long term, they can also experience periods of disappointing performance relative to other single-factor portfolios and even to classic market-cap weighted benchmarks.
This phenomenon has been demonstrated extensively in the academic literature. In a recent paper , for example, Elroy Dimson, Paul Marsh and Mike Staunton noted that “a factor that is ranked high in performance in a particular year may remain high, may end up in the middle, or may slip to low in the following year”. Their research focused on five of the most commonly targeted factors: size, value, income, momentum and low volatility. For each of them, they presented detailed annual return figures recorded since the financial crisis, and ranked the factors from the best to the worst in terms of performance.
Periods of relative underperformance of single-factor portfolios can last for years, testing the patience of many asset owners. A FTSE Russell survey carried out in 2016 actually showed that deciding whether to tactically monitor and adjust exposures to different factors and, if so, how to go about it, ranked seventh among investor concerns when it comes to factor-oriented allocations.
Academics and practitioners continue to debate this issue
Academics and practitioners continue to debate this issue and can be divided into roughly two opposing camps. The first of these assumes single factor performance can be forecasted relatively accurately and therefore advocates tactical factor timing, at least in moderation.
One popular timing approach is to look at the relative valuation of different single-factor portfolios. This usually involves analyzing classic measures of valuation, such as price-to-book or price-earnings ratios. The idea is to increase exposure to factors that trade at a discount compared to their historical norms, and to reduce exposure to those exhibiting high valuation multiples compared to their historical average.
The second group considers factor timing – not to mention general market timing – too difficult, and therefore not really worth the effort . Among other things, they argue that different measures of valuation often lead to conflicting conclusions. Moreover, they think that deciding factor exposure based mostly on its valuation is misguided, since some of the proven factors, such as momentum or quality for example, also typically clash with the value factor.
At Robeco, we agree more with the second approach. As a result, we usually recommend that our clients either opt for broad diversification across the different factors we exploit in our strategies, or for one particular factor of strategic interest, but bearing in mind they will be faced with short term underperformance.
This does not mean valuation should be ignored, on the contrary. As mentioned in a previous article in this series, investors should closely monitor their exposure to the well-established factors and make sure they avoid unintended factor biases.
This is also why the enhanced single-factor definitions, which are used in Robeco’s factor investing strategies, always take valuation criteria, among others, into account. That way, we can avoid buying stocks which are overpriced. This improves both the factor characteristics of our enhanced factor strategies and the efficiency of the exposures both in our single and multi-factor solutions.
1 ‘Factor-Based Investing: The Long-Term Evidence’, Elroy Dimson, Paul Marsh and Mike Staunton, Journal of Portfolio Management, 2017.
2 ‘My Factor Philippic’, Cliff Asness, 2016.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.