The IFED Investment Strategy Celebrates Its 5-Year Anniversary

Over the past five years, the momentum premium was negative in two years, the small firm premium was negative in four years, and the value premium was negative in three years. Wouldn’t it be nice if your portfolio shifted holdings to capitalize on positive risk premiums and avoid negative premiums? EIA designed the IFED strategy to accomplish that goal and the evidence regarding EIA’s success is in.

In the prior five years, Nasdaq IFED-L™ achieved a 21.50% return versus the S&P 500's 15.94%, equating to an annual alpha of 5.56%. Additionally, the index outperformed 99% of the large cap funds reporting to the eVestment database. The IFED strategy is designed to achieve superior performance by targeting risk factors that are in-favor, while avoiding factors that are out-of-favor.

Nasdaq IFED-L was an outgrowth of over 30 years of academic research and is EIA’s first customized index. The index is a large-cap, US equity index and was launched at the beginning of June 2020. As with all IFED indexes, it implements the IFED strategy. The IFED strategy relies on 12 firm financial metrics to select stocks that are positioned to prosper in the market environment identified by the IFED indicator, which assesses Fed policy signals to identify impending shifts in market conditions.

During the past five years, the markets have experienced a myriad of events and market conditions including a pandemic, a severe bear market, two strong bull markets, an inflation spike, fears of a trade war, and both expansive and restrictive Federal Reserve policy. Despite the market turbulence, the IFED indexes performed consistently well throughout the period. Exhibit 1 reports total return for the five years following Nasdaq IFED-L’s launch.  

Exhibit 1. Nasdaq IFED-L Total Return Since Launch, 5/31/2020-5/31/2025

Source: Nasdaq, Factset

Relying on the IFED strategy, Nasdaq IFED-L produced a total five-year alpha exceeding 55%. As noted previously, this superior performance was captured over a tumultuous market period, which supports the robustness of the IFED strategy. The following sections detail the index’s relative outperformance and present compelling evidence that the alpha was captured without subjecting investors to increased risk of loss.

How Does IFED Performance Stack Up Relative to the Competition? 

Capturing alpha in the large-cap arena is extremely challenging and has motivated many investors to adopt a passive, market-indexing approach. The above results indicate that IFED clients have been richly rewarded for embracing the semi-active IFED approach. While the IFED strategy is dynamic, it only shifts portfolio holdings when necessary to maintain alignment with market conditions, i.e., on average, about 1.8 times per year, which avoids excessive turnover and transaction costs.   

Exhibit 2 presents Nasdaq IFED-L’s performance relative to prominent alternative indexes.

Exhibit 2. Performance: Nasdaq IFED-L and Other Large Cap Indexes

Source: Nasdaq, Bloomberg

Exhibit 2 illustrates the out-performance of Nasdaq IFED-L since its launch in 2020. The index beat its benchmark, the S&P 500, as well as all the major factor indexes. While investment styles go in and out of favor, the IFED strategy transitions IFED portfolios away from stocks that have features that have gone out of favor when market conditions change.

Further support for Nasdaq IFED-L’s performance is provided in Exhibit 3, which shows Nasdaq IFED-L's performance relative to the eVestment universe. Exhibit 3 is taken from the eVestment site and shows relative performance of EIA’s Nasdaq IFED-L index over five alternative periods: most recent quarter (MRQ), year-to-date (YTD), 1-year, 3-years, and 5-years.

Exhibit 3. EIA’s Nasdaq IFED-L Performance Relative to Nasdaq eVestment™ Universe

Exhibit 3 illustrates Nasdaq IFED-L’s performance over each of the five periods presented, MRQ, YTD, 1 Year, 3 Years, and 5 Years. Relative to the other approximately 1,000 large cap funds reporting on eVestment, Nasdaq IFED-L ranked in the 7^th, 3^rd, 11^th, 26^th, and 1^st percentiles, respectively, over the five different periods. The consistency of strong performance provides validation for the IFED strategy’s effectiveness and robustness.

Risk Analysis of IFED Strategy

Investment strategies that are designed to capture alpha often take speculative positions, and thus, expose investors to considerable downside risk. In contrast, the IFED strategy avoids periods of material underperformance due to its unique design. Exhibit 4 reports risk measures for Nasdaq IFED-L and its benchmark, the S&P 500.

Exhibit 4. Risk Measures, Nasdaq IFED-L and S&P 500, 5/31/2020 - 5/31/2025

Source: Nasdaq, Factset

The IFED strategy is designed to prosper when normal return patterns prevail, by aligning portfolio constituents with impending market conditions, while limiting underperformance when unusual forces drive returns. The strategy’s success in this regard is reflected by the capture values reported in Exhibit 4, along with the highest and lowest 12-month returns. Nasdaq IFED-L captured far more of the market upside relative to downside - capturing 24% more upside. Furthermore, Nasdaq IFED-L limited the biggest 12-month loss to -8.64% versus a market loss of -18.11%. Finally, Nasdaq IFED-L attained a maximum 12-month gain of 53.21%, whereas the market managed a maximum return that was more than 10% lower, 42.91%.

Regarding downside risk, the data indicates that much of Nasdaq IFED-L’s standard deviation and tracking risk is due to upside deviation, i.e., upside performance. Upside deviation is substantially higher than downside deviation, thus, the total volatility measures present an upwardly biased indication of the true risk of loss inherent in the IFED strategy. Factor-based strategies are extremely popular when their underlying style is in-favor; however, the strategies substantially underperform when they go out-of-favor. In contrast, the IFED strategy is designed to avoid going out-of-favor and the accompanying underperformance.

The IFED strategy incorporates several features to alleviate downside risk and avoid introducing a reliance on speculative elements:

1. the strategy always remains fully invested in equities. Thus, the strategy is not a speculative market timing approach;

2. the 12 financial metrics used in selecting portfolio constituents include several quality measures. The strategy favors stocks with financial strength and stability;

3. the strategy shifts holdings when market conditions change to avoid going out-of-favor;

4. the strategy applies a rules-based, quantitative approach based on firm fundamentals to select stocks, and thus, avoids emotional considerations and investor euphoria. 

The basic premise of the IFED strategy is that the optimal investment style is multi-faceted and depends on market conditions. The strategy advocates that the optimal stock holdings when inflation is the primary concern differ vastly from the optimal group when concerns about economic weakness dominate. In other words, the risk factors that drive stock returns adjust with shifts in market conditions, which explains why investment styles go in- and out-of-favor. The IFED strategy avoids this boom-and-bust cycle by reallocating portfolio holdings when an impending shift in market conditions is signaled.

The consistency of Nasdaq IFED-L’s outperformance vs the S&P 500 is illustrated in Exhibit 5.

Exhibit 5. Rolling 6-Month Alphas, Nasdaq IFED-L, 5/31/2020 – 5/31/2025

 Source: Nasdaq, Factset

The plot in Exhibit 5 corresponds with the IFED strategy design, which is to prosper when normal return patterns prevail, while avoiding significant underperformance when unusual return drivers dominate. Note that underperformance is relatively small and short-lived in comparison to outperformance. In addition, the periods of underperformance are typically followed by periods of substantial outperformance. These observations align with EIA’s research showing that the return patterns underlying the IFED strategy are occasionally obscured by unusual events or irrational investor pricing; however, normal patterns are ultimately restored after short transition periods. Finally, note that the alphas are not concentrated in any time frame, i.e., large positive alphas are observed throughout the 5-year period.

The IFED Strategy and Risk-Adjusted Performance

During most of its live period, Nasdaq IFED-L has contended with the performance of the magnificent mega caps. Occasionally, when their fundamentals were attractive, the IFED strategy selected a few of the magnificent members. Typically, however, these glamour firms were either not represented or were vastly under-represented in IFED portfolios. Given this observation, it is noteworthy that Nasdaq IFED-L outperformed the S&P 500 over the last few years. Exhibit 6 reports risk-adjusted performance for Nasdaq IFED-L and the S&P 500.

Exhibit 6. Nasdaq IFED-L Alpha & Risk-Adjusted Performance, 5/31/2020 - 5/31/2025

 * The Minimum Acceptable Return (MAR) is assumed to be 0%.

**The risk-free rate is proxied by the U.S. 3-month Treasury bill yield.

Source: Nasdaq, Factset

Nasdaq IFED-L has demonstrated impressive risk-adjusted performance since its launch in 2020. The Sharpe and Information ratios are both notable and offer justification supporting the index as a viable investment option.

The Sortino ratio, however, offers the most compelling evidence supporting an investment in Nasdaq IFED-L. The Sharpe and Information ratios measure excess return relative to portfolio volatility, without considering the direction of the volatility. Thus, unexpected positive returns are penalized when these measures are applied. In contrast, the Sortino ratio gauges excess return relative to the probability of loss – i.e., only unexpected negative outcomes are viewed negatively and diminish performance. Nasdaq IFED-L’s Sortino ratio is 23% higher than the S&P 500’s, which strongly supports its overall superiority.

Wrapping Things Up

With Nasdaq IFED-L’s live performance, the IFED strategy has established itself as a robust approach to investment management. EIA’s founders are not surprised by Nasdaq IFED-L’s outperformance over the past five years. Our 30+ year research program examined numerous return patterns to determine those patterns that were systemic versus those that were fleeting. Systemic patterns were identified as having an underlying economic basis and empirical persistence. By ignoring the fleeting return patterns and integrating the systemic patterns into the IFED strategy, the EIA team designed an investment approach that has delivered impressive results.

The IFED strategy is a rules-based, quantitative approach built on a solid foundation of academic research. Furthermore, the strategy is dynamic and relies on multiple factors for portfolio formation. Consider investors holding value funds in 2020 when the value premium was -47% or investors holding momentum funds in 2023 when the momentum premium was -25%. Unlike funds targeting a specific factor, the IFED strategy shifts positions to capitalize on factors that are in-favor and likely to produce positive risk premiums, while avoiding out-of-favor factors that often produce negative premiums. Additionally, the strategy avoids the behavioral biases and emotional decisions that plague other investment approaches and create wild swings in performance. Based on the IFED strategy’s solid foundation and superior performance, the EIA team is confident that the future holds continuing success for the ever-expanding suite of IFED products.

Nasdaq®, Nasdaq eVestment™, and Nasdaq IFED-L™ are trademarks of Nasdaq, Inc. The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

Information set forth in this post contains forward-looking statements that involve risks and uncertainties. Nasdaq cautions readers that any forward-looking information is not a guarantee of future performance and that actual results could differ materially from those contained in the forward-looking information. Forward-looking statements can be identified by words such as “will,” “believe,” “designed to,” and other words and terms of similar meaning. Such forward-looking statements include, but are not limited to, statements related to the performance of Nasdaq IFED-L referenced in the post. Forward-looking statements involve risks, uncertainties or other factors beyond Nasdaq’ control. Nasdaq undertakes no obligation to publicly update any forward-looking statements due to new information, future events or otherwise.