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For equity factor strategies, beware the wrinkles in timing

21 March 2019 | Investing

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Commentary by Doug Grim, senior investment strategist at the Vanguard Group, Inc.

Interest in using equity factor strategies to help clients meet their investment objectives is increasing, and advisors often ask if factor-timing strategies can enhance clients' returns—particularly given the cyclicality of factor returns. It's a tricky question to answer because measuring "success" creates a wrinkle—or challenge—for many.

Ironing out a prudent benchmarking mind-set

When considering which investment strategies to use to meet various objectives, advisors often contemplate what benchmark would be prudent for comparison. In this case, it provides a way of assessing performance relative to how advisors could otherwise strategically deploy their clients' hard-earned assets—without the use of timing. Some believe a low-cost, broad market-capitalization-weighted index fund makes sense as the benchmark for a factor-timing strategy.

For instance, advisors who consider equity factor funds for a timing strategy typically believe that those same factors will outperform a broad-market index fund over the long term without timing. Their objective is for the timing strategy to add to a return that could otherwise be generated by simply buying and holding a diversified group of factors. In this situation, more relevant choices for comparison should be considered to help the advisor determine the true value-add (risk and return) of the timing strategy. These options include:

  • Performance of an equally weighted mix of single-factor strategies.
  • Performance of a multifactor fund that combines factors using bottom-up (integrated) portfolio construction.

These represent practical ways an advisor could strategically tilt toward a set of equity factors in a low-cost, diversified way without judging which factor to overweight or underweight at different times. To make the benchmark comparison truly apples-to-apples, the advisor should consider the impact of all-in costs of each approach, including those when fund trades are made.

Keep it wrinkle-resistant

Advisors who already use equity factor funds to achieve certain investment objectives remind their clients up front that strategically owning single-factor equity funds, as with other types of active strategies, will produce periodic ups and downs. Timing factors, some believe, is a way to make the roller-coaster ride less bumpy and more gratifying (profitable).

Absent a strong conviction about differences in future expected returns and correlations across factors, an equally weighted combination is a sensible, diversified standard for most advisors with excess-return objectives. For those determined to implement a timing approach, appropriate benchmarking is a necessary component of the due diligence required to measure long-term success—and keep the wrinkles in timing at bay.

Doug Grim
Senior Investment Strategist
Vanguard Investment Strategy Group

Important information:

The views expressed in this material are based on the authors' assessment as of the first publication date (February 2019), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The authors may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise. Any "forward-looking" information contained in this material should be construed as general investment or market information and no representation is being made that any investor will, or is likely to achieve, returns similar to those mentioned in this material or anticipated in this material.

While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use.

This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation. Please consult your financial and/or tax advisor for financial and/or tax information applicable to your specific situation.

In this material, references to "Vanguard" are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.

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