The Economic Benefits of Market Timing the Style Allocation of Characteristic-Based Portfolios
North American Journal of Economics and Finance, Vol. 37, pp. 38-62, 2016
47 Pages Posted: 27 Jun 2014 Last revised: 19 Sep 2016
Date Written: February 14, 2016
Many exchange traded funds track simple characteristic-based equity portfolios such as the market capitalization, the fundamental value or the inverse volatility portfolio. This paper provides theoretical and empirical evidence for the economic benefits in exploiting the timing-gains that result from the time-varying relative performance of these characteristic-based portfolios. Under a factor model for expected returns, we show that this dynamic portfolio allocation can be efficient across the low-dimensional set of characteristic-based portfolios. We assess the out-of-sample performance on the S&P 100 universe over the period 1990-2013 and show gains in stability and significant positive risk-adjusted returns for the dynamic style portfolio. We conduct several robustness tests and extensions confirming the benefits of dynamic style allocation across characteristic-based portfolios.
Keywords: ETFs; Factor models; Market timing; Portfolio choice; Stock characteristics
JEL Classification: G11, G12, C22
Suggested Citation: Suggested Citation