Time-Series Variation in Factor Premia: The Influence of the Business Cycle

Abstract

Factor cyclicality can be understood in the context of factor sensitivity to aggregate cash-flow news. Factors exhibit different sensitivities to macroeconomic risk, and this heterogeneity can be exploited to motivate dynamic rotation strategies among five commonly established factors: size, value, quality, low volatility and momentum. A timely and realistic identification of business cycle regimes, using leading economic indicators and global risk appetite, can be used to construct long-only factor rotation strategies with information ratios nearly twice as large as static multifactor strategies. Results are statistically and economically significant after accounting for transaction costs, capacity and turnover.

Keywords: Factor investing, factor rotation, dynamic multifactor, global macro, business cycles, risk premia, factor tilting, factor timing, asset allocation

JEL Classification: G11, G12, G23