Time series variation of factors -The zoo is dynamic

There is a growing zoo of factors that have significant explanatory power through time, but a closer look of this factor zoo suggests that these factors are dynamic and go in and out of favor or significance. Markets are more complex and difficult to understand because the agent who trade are dynamics with changing objective functions. The significance of any factor changes with the firms that constitute the market, the investors and their objectives, and the market environment. It is no easy task to say which factors will be important in explaining cross-sectional returns and out of sample Sharpe ratios. Nevertheless, the recent paper "Time Series Variation in the Factor Zoo" provides a wealth of analysis on the behavior of factor risks.

This is a. complex paper given the wealth of information provided and the subtle conclusions that are generated. It is worth a close read. Perhaps it will be needed to read more than once.  For example, the importance of the classic 3 to 6 factor core Fama-French model varies significantly through time and leads other factors having an important role both in and out of sample. These factors of varying importance will be associated with economic conditions, especially recessions, and with the diversity in firm characteristics. The environment changes and factor importance changes. The diversity of firms requires more factor to explain variation and allows for more factors being important at any time. 

The cross-sectional pricing of stocks is not easy to solve and requires a wide set of factors that will varying in importance. Employing only six factors will not solve the problem as the research suggests that 30-40 factors may be relevant. This research is critical if you want to use factors as a driver for stock-picking and portfolio construction.