IFED Portfolios Rebalance to Stay Aligned with Market Conditions

At the beginning of June 2025, the IFED portfolios were rebalanced to ensure portfolio holdings continue to match prevailing market conditions. The EIA team devoted over 30 years to developing a dynamic investment strategy that relies on Fed signals to keep portfolio composition matched with the market environment. The resulting IFED strategy meets the rigors of academic scrutiny and passes proof-of-concept in the market with its live Invest with the Fed (IFED) indexes.

The IFED strategy relies on 12 firm financial metrics to gauge each stock’s alignment with prevailing market conditions. At the beginning of June 2025, EIA updated each firm’s financial metrics and a new IFED Score was derived for each stock. Portfolio holdings were reallocated based on the updated IFED Scores. On average, IFED portfolios are reallocated about 1.8 times per year, ranking the IFED strategy low on the active management scale.

Performance of IFED Live Indexes

Exhibit 1 shows the relative performance of the three existing EIA indexes since each index’s launch date: Nasdaq IFED-L (June 2020), Nasdaq IFED-LV (July 2022), and IFED-LG1 (March 2024). The three indexes apply the same IFED strategy to alternative investment universes, Nasdaq IFED-L and IFED-LG1 target stocks from the 500 largest U.S. firms, whereas Nasdaq IFED-LV supplements this constraint by restricting holdings to the 250 lowest volatility stocks. Each of these three customized IFED indexes applies minor constraints on liquidity and holdings concentration.

Exhibit 1 reports performance for the three IFED indexes along with each index’s benchmark. In addition, for Nasdaq IFED-L and IFED-LG1, we report performance that reflects the three most prominent investment styles, value, growth, and high beta. For Nasdaq IFED-LV, we include the benchmark and the three most prominent alternative low-risk investment styles.

Exhibit 1. IFED Index Total Returns versus Benchmarks and Alternatives (through 5/31/2025)

The superior live performance of the three alternative IFED indexes establishes the IFED strategy as an effective and viable investment approach. Each index handily beats its benchmark, with Nasdaq IFED-LV nearly doubling the performance of its benchmark over its 3-year existence and Nasdaq IFED-L beating by nearly 50 percent over its 5-year life. Over its limited existence, IFED-LG1 has also soundly outperformed its benchmark and fell only slightly short of the performance of the S&P 500 Growth index. The Growth index was significantly aided by the phenomenal one-year performance of the Magnificent Seven stocks, which have seen wild vacillations in performance over recent years. The superior performance of the three indexes was generated over a period that witnessed considerable uncertainty, which adds further support to the validity of the outperformance.

Alpha capture strategies are often predicated on speculation and therefore subject investors to abnormal risk levels. In designing the IFED strategy, the EIA team integrated several features to avoid underperforming portfolio benchmarks, including favoring firms with quality financial characteristics, staying fully invested, avoiding out-of-favor risk factors, and limiting portfolio turnover. Exhibit 2 reports risk measures for the three IFED indexes discussed previously. We emphasize downside capture because it best reflects the probability of an investor underperforming expectations and/or objectives.

Exhibit 2: IFED Index Risk Assessment (from Launch through 5/31/2025)

* Calculated relative to each index’s benchmark

** Calculated using a minimum acceptable return (MAR) of 1%

The risk statistics in Exhibit 2 provide strong support for the merits of the IFED strategy. IFED indexes are designed to leverage upside market volatility, and hence, the traditional measures of return volatility, i.e., standard deviation and tracking risk, typically exceed benchmark levels. The capture ratios indicate that much of the measured volatility is due to periods of unusually large “positive” return performance, which is a feature integrated into the IFED strategy. Specifically, the strategy is designed to prosper when normal return patterns prevail, while limiting underperformance when unusual forces drive returns.

For each index, upside capture exceeds downside capture, which indicates the strategy effectively leverages upward market movements while limiting exposure to downward movements. This observation supports the strategy’s effectiveness in capturing alpha without subjecting investors to excessive risk of underperformance.

The Sortino ratios for each index are remarkable, which indicates that IFED investors were handsomely rewarded for their exposure to loss. Note that the Sortino ratio correctly penalizes indexes only for periods of unusually poor performance. In contrast, the traditional risk measures and the information ratio apply penalties for performance that differs from average, even if the performance exceeds expectations.  

To date, EIA clients have favored customized portfolios focused on large-cap stocks, thus, the three live IFED indexes are comprised of stocks from the large-cap universe. The large-cap universe and the post 2020 period offer a perfect proving ground for an investment strategy because of the extremely competitive investment universe and the diversity in market conditions. Many managers have conceded to the difficulty of producing alpha in the large cap space and have taken a passive approach by targeting market-matching index funds. The IFED indexes have rewarded EIA’s clients for taking the counter approach.

Based on this backdrop, the success of EIA’s three live indexes provides strong validation for the effectiveness of the IFED strategy. The superior performance was produced within the large-cap space over a period that included a myriad of economic conditions and events including a pandemic, inflation fears, tariff worries, bull and bear stock markets, and expansive and restrictive Fed monetary policies.

The EIA team believes that the merits of the IFED strategy have been established, and investors should consider the application of the strategy to alternative investment sets. Specifically, the research of EIA’s founders suggests the current period represents an opportune time for investors to capture alpha within the small-cap space.

Is Now the Time to Consider Small-Cap Stocks?

EIA’s founders published several academic articles detailing the performance of small-cap stocks across alternative market periods. For example, their research showed that the small firm premium averaged 2% per month during expansive market environments, while not differing materially from 0% during restrictive environments. Based on this and other research, the IFED model favors small-cap stocks during expansive market environments, while being neutral to size considerations during other environments. Since the IFED market indicator currently classifies the market environment as expansive, the EIA team believes it behooves investors to consider increasing their exposure to small-cap stocks.

While Exhibits 1 and 2 detail the effectiveness of the IFED model in selecting among various types of large-cap stocks, Exhibit 3 presents evidence regarding the model’s effectiveness in selecting among small-cap stocks. With each IFED portfolio, the same IFED model is applied; however, it is applied to a different investment universe.

Exhibit 3: Performance of IFED-S and Its Benchmark (S&P 600)

The return data in Exhibit 3 provides strong support for IFED-S’s effectiveness in identifying small-cap stocks that are positioned to prosper in prevailing market conditions. The strategy has been particularly effective during the past five years, producing annual alphas of 14.61%, 12.58% and 9.60%, respectively over the past 5-, 3-, and 1-year periods. This evidence confirms that the IFED strategy’s success extends beyond the large-cap universe.

Exhibit 4: IFED-S Risk Assessment

* Relative to the S&P 600

** Calculated using a minimum acceptable return (MAR) of 1%

The risk metrics reported in Exhibit 4 are very similar to those reported for the large-cap IFED indexes as reported in Exhibit 2. Observing similar statistics across very diverse samples adds strong support for the viability of the IFED strategy. As with large-cap equities, the strategy demonstrates a propensity to select small-cap equities that flourish when normal return drivers prevail, while limiting underperformance when unusual factors drive returns. Note, in particular, the very favorable capture ratios (upside = 130% and downside = 89%) and Sortino ratio (1.38).

The IFED strategy selects stocks with financial features that align with prevailing market conditions. According to the IFED market indicator, the current market environment is classified as “expansive.” During an expansive environment, the IFED strategy favors smaller, neglected firms with strong growth potential, attractive valuations, and above average earnings quality. Exhibit 5 presents the current top 10 holdings for IFED-S.

Exhibit 5: Top 10 Holdings for IFED-S 

Exhibit 5 shows that IFED-S is comprised of a diverse set of firms with a moderate maximum single stock exposure. Specifically, the maximum holding is only 4.71%. The diverse holdings correspond with the IFED strategy’s use of 12 dissimilar metrics in the equity selection process. Furthermore, the strategy relies on metric rank, which diminishes the impact of extreme metric values and helps limit holding’s concentration.

The diversity in holdings is supported by the observation that the top 10 firms include members from six of the eleven alternative sectors. Furthermore, for the top 10 firms, there are no more than two entries in a single sector.

Wrapping It Up

There is an adage in finance that encourages investors to “sell in May and go away.” The idea being that such action would allow investors to miss the normal doldrums associated with the stock market during the summer months. In contrast, the EIA team recommends that this summer investors consider revitalizing their portfolios by increasing their exposure to small-cap stocks.

Despite the extra risk associated with small stocks, for each of the past four years, the small firm premium (return on small stocks minus the return on large stocks) has been negative, averaging small-cap underperformance of 6.3% per year. So, what would change the small-stock underperformance pattern? The Federal Reserve shifted its policy to expansive (a lower rate policy) in September 2024. With inflation concerns abated, every indication is that the Fed will continue this policy for the foreseeable future. EIA team research shows that historically the small stock premium has been pronounced during extended periods of expansive Fed policy. The premium is especially prominent for small firms with the appropriate credentials, i.e., those with the highest IFED Scores. Based on this evidence, we encourage investors to consider the merits of small-cap stocks.