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Decline

12-07-2023 · Insight

A prudent route to effective factor timing

Equity factor investing has become significantly more popular in recent years. The underlying factor portfolios’ returns exhibit distinct cycles, tempting investors to try their hand at dynamically adjusting their factor allocation. However, the key question remains: how can investors best time factors to maximize returns while minimizing risk?

Download the full paper and methodology


    Authors

  • Harald Lohre - Head of Quant Equity Research

    Harald Lohre

    Head of Quant Equity Research

  • Daniël Haesen - Portfolio Manager

    Daniël Haesen

    Portfolio Manager

Summary

  1. Diversification is key for effective factor investing

  2. Additional factor timing benefits depend on accuracy and implementation of timing signals

  3. Dynamic 1/N multi-factor approach improves on static approach when being cost-efficient

Factor timing is the holy grail in equity factor investing. With factors exhibiting underperformance at times, the temptation to dynamically adjust one’s factor allocation is high. Indeed, a clairvoyant factor investor could enjoy sizable outperformance relative to a static factor allocation. In our recent white paper, we explore to what extent this factor timing opportunity set can be tapped in practice. Specifically, we investigate the practical implications of factor timing by considering the role of factor momentum, valuation spreads and seasonality. Indeed, valuation spreads and seasonality signals have predictive power with regards to factor returns; yet these factor timing gains turn out to be more apparent than real as the timed strategy is lagging the benchmark after considering transaction costs. Conversely, factor momentum can add active return before costs, of which almost half can be salvaged after transaction costs.

Notwithstanding, factor momentum brings about high strategy turnover. As a consequence, one has to thoughtfully trade off the associated transaction costs (which are certain) versus the expected factor momentum alpha (which is noisy). Our findings show that a Dynamic 1/N multi-factor approach presents a prudent route to effective equity factor timing by combining low strategy turnover with the pervasive factor momentum effect while maintaining proper factor diversification.

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Read the full paper and methodology here

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In all cases where historical performance is presented, please note that past performance is not a reliable indicator of future results and should not be relied upon as the basis for making an investment decision. Investors may not get back the amount originally invested. Neither Robeco Institutional Asset Management B.V. nor any of its affiliates guarantees the performance or the future returns of any investments. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. Robeco Institutional Asset Management B.V. (“Robeco”) expressly prohibits any redistribution of the Information without the prior written consent of Robeco. The Information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to law, rule or regulation. Certain information contained in the Information includes calculations or figures that have been prepared internally and have not been audited or verified by a third party. Use of different methods for preparing, calculating or presenting information may lead to different results. Robeco Institutional Asset Management UK Limited (“RIAM UK”) is authorised and regulated by the Financial Conduct Authority. RIAM UK, 30 Fenchurch Street, Part Level 8, London EC3M 3BD (FCA Reference No:1007814). The company is registered in England and Wales under Ref No. 15362605.

In all cases where historical performance is presented, please note that past performance is not a reliable indicator of future results and should not be relied upon as the basis for making an investment decision. Investors may not get back the amount originally invested. Neither Robeco Institutional Asset Management B.V. nor any of its affiliates guarantees the performance or the future returns of any investments. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. Robeco Institutional Asset Management B.V. (“Robeco”) expressly prohibits any redistribution of the Information without the prior written consent of Robeco. The Information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to law, rule or regulation. Certain information contained in the Information includes calculations or figures that have been prepared internally and have not been audited or verified by a third party. Use of different methods for preparing, calculating or presenting information may lead to different results. Robeco Institutional Asset Management B.V. is authorised as a manager of UCITS and AIFs by the Netherlands Authority for the Financial Markets and subject to limited regulation in the UK by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request.