The investment environment is often a powerful force in determining the success or failure of any investment style or factor in a given time period. These shifts in style performance can be quite dramatic: as evidenced by periods such as the internet boom of 1999-2000 where momentum investing was the only game in town and the market crash of 2008 where lower risk strategies were successful.
One key feature of our modeling framework is that we dynamically change the weights of the different factors to account for variation in the investment environment. An example is changes in the risk-appetite of investors. At times, investors become too optimistic and drive up the price of longer term assets such as growth stocks, ignoring the current profitability of firms or their cash-flows. Other times, they become too pessimistic and tend towards the “safety” of larger or more profitable firms. These cycles are caused by investors’ behavioral biases that lead them to extrapolate and overweight their recent experience of the macroeconomic environment relative to the long run history. Our proprietary conditional models, developed by Dr. Venkat Eleswarapu, are designed to exploit these cycles by examining today's investment environment and predicting which factors are likely to be favored from that starting point.
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