If switching between positive and negative sides seems underwhelming in comparison to just holding the positive side of the factor passively, what about the prospects of rotating between different positive sides?
Below we plot the growth of (1) a factor rotation strategy that rebalances monthly using 12-1 momentum to buy the top-three-performing factors equally; (2) a portfolio that equally weights the factors; and (3) the market.
Data Source: Kenneth French Data Library. Calculations by Newfound Research. Past performance is not a guarantee of future returns.
What we can see is that momentum-based factor rotation not only beats the market, it also beats a passive, diversified factor portfolio.
Yet once again, the “long-term” may distort the picture. The factor rotation strategy only outperforms the equal-weight factor portfolio by 1.32% per year. If we consider manager costs and transaction costs in the equation (estimating, again, an all-in cost of 0.85%), this relative outperformance falls to 0.47%.