Cycle-based factor timing: Clear in hindsight but hazy ahead
10 July 2019 | Portfolio construction
Cycle-based factor-timing strategies require moving in and out of factors based on knowledge of which factors have performed best under various economic conditions. Investors must gauge their ability to identify the key inflection points in advance. Vanguard’s new Global Macro Matters paper studies the success of basing such strategies on historical returns.
We find that hindsight bias can greatly exaggerate potential returns. A cycle-based factor-timing strategy founded on historical performance may not live up to expectation because of inconsistent factor performance in different cycles and imperfect judgment in foreseeing the beginning and end dates of these cycles. When assessing the validity of such a strategy, due diligence is a vital step in identifying hazards, such as hindsight bias, that can greatly exaggerate potential returns.