At Lunt Capital, we are less focused on the sustainability of outperformance for specific factors than we are excited about the large dispersion of performance across factors within a specific asset class. Dispersion is necessary to justify tactical risk. For example, the U.S. Large Cap Momentum factor often looks and behaves differently than the U.S. Large Cap Low Volatility Factor. Both factors have merit, but even long-term outperformance includes seasons of underperformance. Both could be held in a strategic allocation that attempts to capture long-term factor outperformance. Additionally, a tactical strategy could be applied to rotate between Momentum or Low Volatility in an attempt to capture whichever of the two factors seems to be “in season.”
We believe there is virtue in creating allocations dedicated to single factors or combinations of factors. However, we also recognize tremendous opportunity in applying strategies that rotate to the factor that seems to be “in season.” Factor rotation introduces tactical risk/opportunity in addition to the underlying factor risk/opportunity. We believe thoughtful diversification includes both asset class and strategy diversification. Just as investors have embraced the factors represented by Smart or Alternative Beta, we believe they will embrace the next ETF evolution represented by factor rotation or Tactical Beta. (I recognize the term “Tactical Beta” is an oxymoron, but it represents a concept we have long talked about at Lunt Capital, which is attempting to create alpha through the tactical management of asset classes, sector, and factor betas). At Lunt Capital, we also use the terms “Adaptive Beta” or “Dynamic Factors” to highlight the importance of rotating or adapting to the factor or asset class beta that is “in season.”
SEE MORE: Tactical ETF Strategies Have Transformed Investing
It is valuable to understand the characteristics of Market Beta, Smart Beta, and Tactical Beta. Each offers attributes that may be useful and important as part of overall portfolio construction. Investors should consider diversifying their Beta. As we collectively attempt to capture opportunities and to manage risks, we can’t ignore one of the emerging themes in the ETF industry— “Tactical Beta” or the importance of “Getting Active with Factors.”