Future stock returns are unknown. However, numerous articles in the finance literature find that stocks with certain characteristics tend to have higher returns than others. For example, Fama and French (1992) find that in long run, Value stocks (stocks with high B/M) tend to offer significantly higher returns than Growth stocks (stocks with Low B/M). They take the difference of returns of Value and Growth stocks as the return on Value factor. Similarly, Titman and Jagadeesh (1993) find that in long run, Winner stocks (stocks with good performance over that past 12 months) outperform Loser stocks (stocks with bad performance over that past 12 months). They take the difference of returns of Winner and Loser stocks as the return on Momentum factor. As the other well-known factors, one can mention Size (Banz, 1981), Low-volatility (Blitz and van Vliet, 2007), Profitability and Investment (Fama and French, 2015).
Although several studies - in various time periods and investable universes - find that the average returns on the aforementioned factors are in long run significantly positive, the corresponding strategies are not always profitable. Individual factors can experience periods of disappointing performance. For instance, Daniel and Moskowitz (2016) find that Momentum factor can experience infrequent and persistent strings of negative returns. They claim that these loses of Momentum factor are to some extent predictable. As another example on predictability of Size factor see Greenwood and Hanson (2012).
Finding robust evidence of factor returns predictability enables asset managers to “time the factors”, i.e. to dynamically increase or decrease the weight of each factor depending on its future expect return. In the finance literature, factor timing has been an area of ongoing debate. While some authors find factor timing profitable, many believe that these benefits are observed with the benefit of hindsight and thus suffer from overfitting and data mining.
In this research project, we are eager to further study the factor returns predictability in various countries, time periods and investment horizons. We would like to find the main drawbacks of factor timing and investigate the possibility of turning these threats to investable opportunities.
Banz, 1981, “The Relationship between Return and Market Value of Common Stocks”, Journal of Financial Economics
Blitz, van Vliet, 2007, “The Volatility Effect”, Journal of Portfolio Management
Fama, French, 1992, “The Cross-Section of Expected Stock Returns”, Journal of Finance
Fama, French, 2015, “A five-factor asset pricing model”, Journal of Financial Economics
Jegadeesh, Titman, 1993, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency”, Journal of Finance
Greenwood, Hanson, 2012, “Share issuance and factor timing”, Journal of Finance