Waiting for the Next Factor Wave: Daily Rebalancing around Market Cycle Transitions

Abstract

To deliver historically observed factor premiums, long-only factor investing relied heavily on a small number of periods, when factors realized outsized returns in the midst of changing market leadership. This article shows that by rebalancing factor funds more frequently during these periods—rebalancing on a daily basis instead of monthly or biannually—investors would have achieved significantly higher factor premiums, effectively doubling the historically observed premiums of many factors. These findings indicate that to harvest factor premiums to their maximal potential, skill is needed on the part of the fund manager—an ability to tell the right moment to aggressively rebalance.

TOPICS: Analysis of individual factors/risk premia, factor-based models

Key Findings

• ▪ Historically, long-only factor investing relied heavily on a small number of periods with outsized returns to deliver factor premiums. These periods coincided with market cycle transitions when the makeup of market leadership changed dramatically.

• ▪ By rebalancing frequently—daily instead of every month or six months—during market cycle transitions, a factor investor would have achieved significantly higher factor premiums, effectively doubling the historically observed premiums. This finding holds true even after accounting for much higher transaction costs driven by the higher turnover.

• ▪ Our findings indicate that an ability to tell the right moment to rebalance more frequently may be central to harvesting factor premiums to their maximal potential.