Cliff Asness, founder of AQR Capital Management, is back
again arguing that factor timing is deceptively
difficult despite what you may have heard from Research
Affiliates chief executive officer Rob Arnott.
In a research report and
blog post, Asness takes issue with a series of white papers
published by Arnott and his colleagues, which presented
evidence in favor of a contrarian approach to factor timing
based on what Asness called a plethora of mostly
inapplicable, exaggerated, and poorly designed tests that also
flout research norms.
For several years now, a debate has raged over whether risk
premia factors such as value, momentum, growth, and
volatility have become overvalued as a result of the
rising popularity of smart beta and factor investing
strategies. While some, like Research Affiliates and founder
Arnott, believe factors can become expensive and that
investors should time their exposures to buy low and sell high,
others, like Asness, argue that diversification, not timing, is
the best way to achieve returns through factor exposures.
Together with three AQR co-authors Swati Chandra,
Antti Ilmanen, and Ronen Israel Asness put Research
Affiliates conclusions to the test this month, first by
evaluating whether any factors are overvalued and then by
applying a value-based timing strategy to a multi-factor
portfolio. The first question was dismissed fairly quickly.
While, not surprisingly, some of these factors are
cheaper and some are richer compared to historical norms, none
are near bubble-level extremes and collectively they do not
paint a picture of very stretched valuations in either
direction, the authors wrote in the research report.
For the second question, the researchers measured the
performance of single and multi-factor strategies when each of
the factors was and was not timed. While value timing did
improve both returns and Sharpe ratios for a momentum
portfolio, Asness argued that this diversification benefit
could be more efficiently achieved by simply adding a strategic
allocation to value.
Furthermore, as the baseline portfolio became more
diversified with more factors, it became progressively
harder for value timing to improve its performance
even before considering the added turnover and transaction
costs resulting from factor timing, Asness and his co-authors
said in their report.
Our own slew of trading simulations ... fails to
produce economically meaningful improvement in either gross
returns or gross Sharpe ratios, underscoring the difficulty of
successfully implementing contrarian factor timing, they
wrote. Our research supports the approach of sticking to
a diversified portfolio of uncorrelated factors that you
believe in for the long-term, instead of seeking to tactically