Want Smart Beta? Follow the Smart Money: Market and Factor Timing Using Relative Sentiment

Abstract

We present a real-time, cross-asset, positions-based relative sentiment indicator to predict the U.S. equity market. Derived from the Commitments of Traders report, the indicator measures — in a novel way — the aggregate positioning in equities of institutional investors relative to individual investors. Applying a wide range of statistical tests and controlling for data snooping, we find this indicator to be highly significant, exceptionally robust, and substantially more powerful than both value and momentum in predicting equity returns. Beyond the broad market, the indicator also facilitates the timing of several “smart beta” equity factors — many of which were thought difficult or impossible to time. We propose a tactical asset allocation strategy based on the indicator and compare it to several value- and/or momentum-based alternatives — finding the proposed strategy produces higher returns (both absolute and risk-adjusted), while having considerably less time-averaged exposure to equities.

Keywords: Market Timing, Factor Timing, Smart Beta, Smart Money, Investor Sentiment, Relative Sentiment, Time-Series Momentum, Tactical Asset Allocation, Commitments of Traders

JEL Classification: G10, G11, G14, G17