The Fab Four of Factor Timing

Style factors are well-established as systematic sources of risk and return in financial markets over the long run. But the question of investors timing their exposure to these factors is challenging and vigorously debated. Timing on the basis of relative valuations can be difficult, given the persistence of factor, or antifactor, performance over extended periods. Some academic evidence seeks to link factor performance to the business cycle. The idea is that, by identifying a set of variables linked to the general economic environment, a factor-timing strategy can work. In this article, we present a systematic factor timing approach based on a set of four categories of academically supported explanatory variables: the business cycle, factor momentum, factor volatility, and tail events in traditional markets. We combine these explanatory variables, subject to certain constraints, to demonstrate the potential for a statistically significant alpha from this factor timing strategy against its broad equity benchmark.