Using Fed Policy Signals to Capture Alpha: The IFED Strategy
White Paper Synopsis
This article provides insight to the origins of the IFED strategy and its efficacy. The IFED strategy is rules-based and represents a unique combination of top-down and bottom-up investment approaches. The strategy relies on twelve firm-specific financial metrics to select stocks, which integrates a bottom-up dimension into the strategy. The weights applied to the twelve metrics, however, are conditional on the market environment, as defined by gauging Fed policy signals. Relying on Fed policy signals to guide stock selection introduces a top-down dimension that makes the IFED strategy dynamic and forward looking.
Combining the two dimensions into an executable investment approach led to the launch of the Nasdaq IFED Large-Cap US Equity Index (Nasdaq IFED-L) on June 9, 2020. Since its June 2020 launch, Nasdaq IFED-L has been the best performing large-cap US equity index, producing a total return of 49.99%. Furthermore, the index has produced an average alpha (vs the S&P 500) of 7.61% per year over its entire backtested history from January 1, 1999 through August 31, 2022.
Economic Index Associates (EIA) is excited to partner with Nasdaq in promoting the IFED strategy to the global investment community. We look forward to future collaboration on a suite of indexes that apply the IFED approach.
This white paper examines the performance of several U.S. equity indexes, created using EIA's Invest with the Fed methodology, for the 39-year period from 1979 through 2017.
White Paper Synopsis
The IFED strategy extends traditional smart beta and factor-based products to create dynamic indexes that adjust when economic conditions warrant. We use Fed policy signals as the IFED reallocation indicator and rely on twelve firm financial metrics to determine the optimal equities in which to shift the underlying portfolio. The twelve metrics are used to identify firms that prosper under each alternative monetary environment. When the IFED indicator signals a shift in policy, the portfolio is reallocated to equities with features that are conducive to the new policy. Over the 39 years, our All-Cap Index earns an annual return of 19.18% versus 12.52% for the Wilshire 5000; further, both indexes experience similar volatility. Consistent with the penchant for small firms to have greater sensitivity to monetary conditions, our Small-Cap Index performs considerably better. Specifically, over the same period, our Small-Cap Index returns 20.25% versus 13.07% for the Russell 2000, and further, our Small-Cap Index subjects investors to less risk.