Factor Information Decay : A Global Study

This research addresses a simple but important unanswered question in the factor investing literature: how do the factor exposures of equity factor strategies decay over time? The answer to this question has two important practical consequences. Firstly, understanding how a strategy’s factor exposures change over time informs the optimal rebalancing period. Secondly, when coupled with factor risk premia estimates, it describes the term structure of expected returns per factor strategy. To answer this question, we conduct a large-scale empirical study of five well-known factors - Value, Momentum, Quality, Investment and Low Volatility - across 12 developed and emerging markets over the last 20 years. We calculate factor exposure, or information, distributions per market for both pure and quartile long/short factor portfolios, and then analyse how these distributions decay over a 36-month holding period. In order to formally measure the rate of information decay, we introduce the idea of a factor half-life metric and use the global half-life results to propose optimal rebalancing periods per factor