PT  - JOURNAL ARTICLE
AU  - Shaojun Zhang
TI  - Factor Construction Zoo: Are Factor Exposures Created Equal?
AID  - 10.3905/jpm.2021.48.2.105
DP  - 2021 Dec 31
TA  - The Journal of Portfolio Management
PG  - 105--118
VI  - 48
IP  - 2
4099  - https://pm-research.com/content/48/2/105.short
4100  - https://pm-research.com/content/48/2/105.full
AB  - The answer is no. Factor investing provides investors with a low-cost avenue to participate in stock selection. Investors earn excess returns for taking on factor risk, which is often measured by factor exposure. However, the relation between the return and factor exposure is nonlinear. Large-scale simulation shows that similar target factor exposures can be engineered using various portfolio construction methodologies, but the resulting portfolios exhibit significant dispersion in expected returns and co-movement with the market and across factor funds. The dispersion increases with target factor exposures. As such, some factor exposures are more efficient than others. This article further studies a comprehensive list of portfolio construction choices for value, momentum, and quality funds; discusses the trade-off at work; and provides a framework for the assessment of factor exposure efficiency. It is important to account for nonlinearity in constructing or evaluating factor funds.