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Don’t Try to Time Factor Strategies (Part 2)

Investors often have to wait a long time before valuations mean-revert, which can make it challenging to adhere to such a contrarian approach.

Alex Bryan 05.01.2017

In part 1 of this article, we looked at the relationship between valuations and future performance. In part 2 of this article, we will continue to explore if timing factor strategies will work.

The scatterplot below illustrates this point for the large-value factor. The X-axis shows the ratio of the valuation multiple of the Russell 1000 Growth Index to the Russell 1000 Value Index. The Y-axis shows the performance differential between the value index and the growth index during the ensuing five-year period. The positive relationship between relative valuations and performance is evident. But the strength of this relationship diminishes significantly after excluding the rolling five-year periods beginning in 1999 through 2000. These are highlighted in red in Exhibit 3. Excluding these periods, the explanatory power of the value and small size factor regressions falls considerably, as shown in Exhibit 4.

170105 Timing factors 03(EN)

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About Author

Alex Bryan

Alex Bryan  Alex Bryan, CFA is the Director of Passive Fund Research with Morningstar.

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