Dynamic Indexes: Equity Rotation and Factor Timing
28 Pages Posted: 14 Mar 2016 Last revised: 22 May 2017
Date Written: May 22, 2017
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  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 , 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: Suggested Citation