AQR Founder Cliff Asness has
warned that factor
timing is “very difficult to do well.” But some hedge fund managers may
have the skill to pull it off, according to new research.
A study focusing on factor
timing ability of more than 3,000 hedge funds from January 1994 to April 2014 concluded
that managers as a whole “do possess factor timing skills,” with the most skillful
hedge funds delivering alpha of 0.96% annually through factor timing.
These top-performing funds
tended to be younger and smaller, have higher incentive fees, have a smaller
restriction period, and make use of leverage, found Netherlands-based KAS Bank analyst Bart
Osinga and finance professors Marc Schauten and Remco Zwinkels of the Vrije Universiteit Amsterdam.
“These funds are more flexible
to engage in factor timing strategies due to the younger and smaller
environment,” they wrote. “More flexible funds have better factor timing
Meanwhile, higher incentive fees
and smaller restriction periods are likely to draw in more skillful managers, the authors argued.
“A shorter restriction period
is preferable for investors,” they continued. “Thereby, funds with smaller
restriction periods can theoretically attract more investors, which in turn can
result in attracting higher skilled managers.”
Although skills varied across
investment styles, the authors found managers overall possessed “strong” ability in
timing market, size, and bond risk factors. The emerging markets factor,
meanwhile, was the subject of “substantially negative timing”—a result they attributed to herding behavior.
“This study presents broad and
strong evidence for the factor timing skills of hedge fund managers,” Osinga, Schauten, and Zwinkels concluded. “A better understanding of [these skills] is important for investors to make a better investment decision and
important for the managers themselves to learn from.”
Read the full paper, “Timing
is Money: The Factor Timing Ability of Hedge Fund Managers.”
Try to Time Factors, Says Cliff Asness & A Factor