“It’s really a culmination of five years where we’ve been asking really hard questions about factors,” John West, Managing Director and Head of Client Strategies at Research Affiliates, said at the Morningstar conference. “What’s the economic rationale? Why should they outperform in the future? After all, back test doesn’t produce any client benefit. and once that we understand the theory behind it then you have to actually say, ‘do the numbers back up the theory?'”
Furthermore, the dynamic aspect starts with an equal weighting to each factor plus an additional weight based on a calculation of a factor’s standard momentum and long-term reversal signal relative to other factors. The additional weights to a specific factor are capped at a max of 15% and a minimum of -15% relative to the equal weights.
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The methodology also creates factor portfolios focused on an individual factor other than momentum. These factor based sugroups are reconstituted in four so-called tranches with each tranche reconstituted in each quarter. The staggered rebalancing is intended to diversify risk.
“At the end of the day, what we’ve come up with is something we’re really proud of,” West said. “We think it’s going to result in a smoother path outpeformance and, very importantly, we’re partnering with our long-term affiliate PIMCO to bring these to market.”
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