Dynamic Indexes: Equity Rotation and Factor Timing

28 Pages Posted: 14 Mar 2016 Last revised: 22 May 2017

See all articles by Lars Kaiser

Lars Kaiser

University of Liechtenstein

Date Written: May 22, 2017

Abstract

It is well-known that factor premiums, identified as contributing to portfolios risk and return, are time-varying and conditional on market phases. Thereon, this paper builds on Fernholz's [1989] diversity-weighted indexing approach to derive a systematic and transparent method to dynamically adjust a portfolios factor exposure over time. The empirical results show that resulting portfolios correspond to a factor rotation, whilst demonstrating favorable after-cost properties regarding risk-adjusted returns, downside deviation, concentration and tracking error. Additionally, introduced method limits extreme positions in certain assets by encompassing portfolios with an implicit active risk constraint such that a natural upper and lower weight bound exists. Given these properties and following the definition by Lo [2016], this approach lends itself for the construction of (dynamic) index funds based on its transparent, systematic and investable outcome.

Keywords: market timing, portfolio rotation, risk premia, diversity weighting, vix, Fama-French, Carhart, active share, tracking error

JEL Classification: G11, G17

Suggested Citation

Kaiser, Lars, Dynamic Indexes: Equity Rotation and Factor Timing (May 22, 2017). Available at SSRN: https://ssrn.com/abstract=2746510 or http://dx.doi.org/10.2139/ssrn.2746510

Lars Kaiser (Contact Author)

University of Liechtenstein ( email )

Fürst Franz Josef Strasse
Vaduz, 9490
Liechtenstein
+423 265 1186 (Phone)

HOME PAGE: http://www.uni.li/lars.kaiser

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