Not All Factor Exposures Are Created Equal

Abstract

Approaches to quantitative equity investing have evolved markedly. Thirty years ago, the focus was on alpha generation, but with the recent decade’s acceptance of smart (alternative) beta, the focus is turning to transparent methods of construction for factor investing. In this article, the authors present an approach for evaluating various methods of portfolio construction that lead to the same factor exposures. Four portfolios are of interest: factor weighted, cap weighted, equal weighted, and risk parity weighted. The authors compare these portfolios based on standard performance statistics as well as new metrics of value-added, such as performance participation rates and portfolio sector concentrations. The results indicate that once the desired factor exposure is achieved, it is beneficial to build the portfolio with the most desirable characteristics in terms of diversification.

TOPICS: Factor-based models, portfolio construction