Why rotate
between factors?

Each of the traditional factors tends to exhibit outperformance
vs. the benchmark over the long term. However, they also
can experience periods of underperformance which may frustrate
the investor.

If one were to invest in a single-factor strategy, they’d be subject to those periods of underperformance. During these periods of short-term underperformance, emotional investing often gets the best of us and can lead investors to give up on a long-term investing strategy. Unfortunately, since factors can move in and out of favor quickly, giving up on a factor investing strategy can lead investors to miss out on periods of outperformance that follow the short-term periods of underperformance.

For example, if you look at the chart below, low volatility stocks were amongst the worst performing stocks in 2012 and 2013. But they turned around in the subsequent two years and outperformed the benchmark S&P 500, including 2014, where the low volatility factor had the best performance of all the factors displayed.

If an investor had become frustrated with low volatility stocks in 2013 and gave up on the strategy, they would’ve missed out on the outperformance of low volatility stocks in the subsequent two years.

The chart above, which is based on S&P factor based indexes, also shows the performance dispersion of the different factors each year. When one factor is struggling, other factors are often doing well. This is why we at Pacer ETFs believe in utilizing a multi-factor rotation strategy.

Rather than suffering through periods of short-term underperformance from a single factor, investors can take advantage of factors’ performance dispersion by rotating between factors and owning only the factors exhibiting the best risk-adjusted performance during that period. Since factors move in and out of favor, a dynamic strategy that broadens the investing universe and utilizes multi-factor rotation may allow investors to take advantage of varying market conditions to maximize investment returns.