Different Approaches, Same End
As discussed previously, when it comes to factor analysis, no factor works all the time. The best a factor-based approach can reasonably hope for is to be right more often than it is wrong. The bigger risk, however, is that most factor analysis does nothing to address the biggest “factor” of all—market risk. A fully invested portfolio that tilts toward low volatility, or any other factor, is unlikely to avoid significant losses should the markets sell off by 30%, 40%, 50% or more. This topic is explored in our blog post on smart beta strategies and systematic risk.
For those low volatility strategies that employ a top-down, market timing approach, the risks are different. As stated before, the key to success with the market is being in the right place at the right time. The risks, however, are being in the wrong place at the wrong time. If one “misses the boat” with their tactical asset allocation decisions, either absolute or relative performance can suffer greatly. Market-timing is explored in depth in this blog post, but can be summarized with the old catchphrase, “Live by the sword, die by the sword.”