The debate over whether it is possible to time factors recurs, appropriately enough, like clockwork.
Its principal interlocutors have been Rob Arnott at Research Affiliates and AQR’s Cliff Asness. In brief, the former has contended that investors should pay attention to whether a factor is expensive or cheap relative to its own history, while the latter has dismissed attempts to time factors as a ‘siren song’.
A new exchange-traded fund (ETF) announced by Virtus at the end of May should provide another voice in this discussion.
The Virtus WMC Global Factor Opportunities ETF will be run by Gregg Thomas and Thomas Simon from Wellington Management Company, respectively associate director for investment strategy and risk and director of equity risk management for investment strategy and risk at the firm.
Thomas is currently a Citywire + rated manager of several subadvised funds for Hartford and Wilmington, while late last year Simon was named as an additional portfolio manager on two Hartford products.
Their new ETF will invest in global equities – with exposure maintained to at least three different countries – tactically according to three different factors: mean reversion, ‘the theory that market prices eventually return to a mean or average price’; trend following, ‘the theory that strong areas of the market will remain strong and weak areas of the market will remain weak’; and risk aversion, ‘the theory that investors will choose the least risky alternative when selecting between investments with similar expected returns.’
So although the material released so far doesn’t mention the factors by name, the ETF appears to be an actively managed value, momentum and low-volatility strategy. It will also focus on ‘tail risk diversification’ by ‘seeking to manage the risk of a significant negative movement in the value of the fund’s investments.’ A fee schedule has not been disclosed yet.
Time in the market too
If the managers can tilt to and from those factors at opportune moments, the rewards should be significant. Value and momentum have historically been negatively correlated, so picking the right one at the right time has proved exceedingly successful, but blending the two should also smooth a portfolio’s return profile. Adding low volatility should contribute to the latter endeavor too.
If the objective is simply to maximize returns, research published earlier this year by Klaus Grobys and Sami Vahamaa of the University of Vaasa in Finland demonstrated how swinging between value and momentum generated significant alpha.
Grobys and Vahamaa took market contagion – when volatility in one asset class or sector spills over into another – as their cue to switch factors, backing momentum in quiet periods and value amid volatility.
This trading strategy, which could be enacted in real time based on observed volatility rather than only with hindsight, left their portfolio in momentum around 80% of the time.
In their sample of US equities from December 1931 to September 2015, their switching process returned a cumulative 670%, outperforming both the 450% from value and 600% from momentum alone and the 500% from a 50/50 portfolio of both factors.
Factors attract us
Factor timing can, in short, work – although the Virtus ETF will not take such a binary approach. In actively managing factor exposure, though, it will distinguish itself from the existing range of multifactor products that are more quantitative in nature.
Some of the largest are the FlexShares ‘Factor Tilt’ ETFs, with the US equity version holding $1 billion. These, however, draw only on the size and value factors. The US ETF, with a net expense ratio of 0.25%, nevertheless returned 16.6% in the year to the end of May compared with 15.1% from the S&P 500 index.
The larger passive players all have smaller multifactor ETFs. iShares, for example, has several ‘Edge Multifactor’ funds but its most popular has only $492 million of assets. This one, again for US equities, incorporates the value, quality, momentum, and size factors. With an expense ratio of 0.2%, it delivered 18% in the 12 months to the end of May, again ahead of the broader market.
For its ‘StrategicFactors’ suite, State Street combines value, quality, and low volatility via an equal weighting those three MSCI indices.
Its largest offering in this space, though, is its emerging-markets ETF with $185 million of assets; its US equity equivalent, launched in April 2015 so hardly a neophyte, hosts a mere $35 million despite an expense ratio of only 0.15%. It has underperformed the S&P 500 over the year to the end of May, returning 14.8%, hampered by its greater exposure to the low-volatility factor.