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Article

Accounting for Cross-Factor Interactions in Multifactor Portfolios without Sacrificing Diversification and Risk Control

Noël Amenc, Frédéric Ducoulombier, Mikheil Esakia, Felix Goltz and Sivagaminathan Sivasubramanian
The Journal of Portfolio Management Special QES Issue 2017, 43 (5) 99-114; DOI: https://doi.org/10.3905/jpm.2017.43.5.099
Noël Amenc
is a professor of finance at EDHEC-Risk Institute and CEO of ERI Scientific Beta in Singapore. noel.amenc@scientificbeta.com
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  • For correspondence: noel.amenc@scientificbeta.com
Frédéric Ducoulombier
is an associate professor of finance at EDHEC-Risk Institute and director of Risk and Compliance at ERI Scientific Beta in Singapore. frederic.ducoulombier@scientificbeta.com
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  • For correspondence: frederic.ducoulombier@scientificbeta.com
Mikheil Esakia
is a quantitative research analyst at ERI Scientific Beta in Nice, France. mikheil.esakia@scientificbeta.com
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  • For correspondence: mikheil.esakia@scientificbeta.com
Felix Goltz
is the head of applied research at EDHEC-Risk Institute and research director at ERI Scientific Beta in Nice, France. felix.goltz@scientificbeta.com
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  • For correspondence: felix.goltz@scientificbeta.com
Sivagaminathan Sivasubramanian
is a quantitative research analyst at ERI Scientific Beta in Nice, France. sivagaminathan.sivasubramanian@scientificbeta.com
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  • For correspondence: sivagaminathan.sivasubramanian@scientificbeta.com
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Abstract

In this article, the authors compare different approaches for constructing multifactor equity portfolios: bottom-up score-weighting approaches that target high-factor intensity and top-down approaches that also consider diversification objectives. They find that focusing solely on increasing factor intensity leads to inefficiency in capturing factor premia, because exposure to unrewarded risks more than offsets the benefits of increased factor scores. High factor scores in bottom-up approaches also come with high instability and turnover. The authors introduce an approach that considers cross-factor interactions in top-down portfolios through an adjustment at the stock-selection level. While producing lower factor intensity than bottom-up methods, this approach leads to higher levels of diversification and produces higher returns per unit of factor intensity. The authors report that it dominates bottom-up approaches in terms of relative performance, while considerably reducing extreme relative losses and turnover.

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The Journal of Portfolio Management: 43 (5)
The Journal of Portfolio Management
Vol. 43, Issue 5
Special QES Issue 2017
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Accounting for Cross-Factor Interactions in Multifactor Portfolios without Sacrificing Diversification and Risk Control
Noël Amenc, Frédéric Ducoulombier, Mikheil Esakia, Felix Goltz, Sivagaminathan Sivasubramanian
The Journal of Portfolio Management Mar 2017, 43 (5) 99-114; DOI: 10.3905/jpm.2017.43.5.099

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Accounting for Cross-Factor Interactions in Multifactor Portfolios without Sacrificing Diversification and Risk Control
Noël Amenc, Frédéric Ducoulombier, Mikheil Esakia, Felix Goltz, Sivagaminathan Sivasubramanian
The Journal of Portfolio Management Mar 2017, 43 (5) 99-114; DOI: 10.3905/jpm.2017.43.5.099
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  • Article
    • Abstract
    • ACADEMIC FOUNDATIONS OF FACTOR INVESTING
    • FACTOR INDEXING AND BOTTOM-UP APPROACH
    • RECONCILING DIVERSIFICATION AND FACTOR EXPOSURE OBJECTIVES IN A TOP-DOWN FRAMEWORK
    • CONCLUSION
    • ENDNOTE
    • REFERENCES
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