Style rotation ETF STrategy

Background and Development:

  • The strategy is developed and managed by John Lyon, Portfolio Manager at Lyon Capital Management.

  • The Core Theory: Value investing tends to work well over a period of many decades. However, there are extended periods of time, such as the late 1990s or the 2010s, in which value stocks underperform but other equity investing styles, such as growth or profitability, outperform.

  • The strategy seeks to invest in value stocks when they have been outperforming and invest in other equity styles when value stocks are underperforming.

Strategy Overview:

  • The strategy rotates between six exchanged-traded funds (ETFs) that track the following equity styles:

    • Large Cap Value

    • Small Cap Value

    • Momentum

    • Profitability

    • Low Volatility

    • Large Cap Growth

  • We have developed a model that evaluates these six ETFs based on their performance over the past several months, or their “momentum.”

  • The strategy over-weights the ETFs with the strongest momentum and underweight the ETFs with the weakest momentum, investing as much as 40% of the portfolio in the top-ranked ETF.

  • We rebalance the portfolio once a month. This frequent rebalancing results in higher turnover, which means the strategy is better in tax-deferred accounts.

Goals of the Strategy:

  • The strategy provides exposure to six equity styles that have historically provided either higher returns than the overall market or returns in line with the overall market with less risk, or volatility, than the overall market.

  • It seeks to limit exposure to value stocks when they are underperforming and over-weight value stocks when they are outperforming.

  • When value stocks are underperforming and underweight in the strategy’s model, the strategy can invest in complementary styles like growth, profitability, momentum, or low volatility. Historically, some or all of these strategies have outperformed when value has underperformed.

  • Our performance goal for the strategy is to generate returns of 1 to 3 percentage points per year above those of both the S&P 500 and the Russell 1000 Value indices with similar or moderately higher risk than the S&P 500 over a 20-year period. While we hope for strong short-term performance, this strategy is designed to be employed with a long time horizon over multiple market cycles.