Securities are then determined by selecting companies based on fundamental weight, calculated using four accounting measures from company financial statements: de-levered sales, calculated as company sales averaged over the past five years multiplied by the ratio of average equity to average assets; cash flow, taken as the company operating cash flow averaged over the past five years; dividend plus buybacks, calculated using the average dividends paid and share buybacks over the past five years; and book value, taken as the most recent company book value.
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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.
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.
Financial advisors who are interested in learning more about multi-factor, smart beta strategies can register for the Tuesday, October 31 webcast here.