PT  - JOURNAL ARTICLE
AU  - Rob Arnott
AU  - Vitali Kalesnik
AU  - Lillian Wu
TI  - Mitigating the Hidden Risks of Factor Investing
AID  - 10.3905/jpm.2022.1.454
DP  - 2022 Dec 31
TA  - The Journal of Portfolio Management
PG  - 111--124
VI  - 49
IP  - 2
4099  - https://pm-research.com/content/49/2/111.short
4100  - https://pm-research.com/content/49/2/111.full
AB  - Several hidden risks of factor investing can lead to investor disappointment; even diversified baskets of factors are prone to sharp drawdowns and prolonged periods of underperformance. Accordingly, the authors explore a variety of techniques to improve the risk-adjusted returns of individual factors and factor portfolios. Introducing a new two-step volatility management method that adjusts the length of the estimation window to scale factor returns, the authors find that this technique is effective in improving both risk-adjusted returns and the trade-off between performance improvement and turnover characteristics. Ultimately, coupling this novel two-step approach with an optimization technique that captures both volatility and correlation information leads to improved risk-adjusted performance, lower volatility of volatility, and improved kurtosis and drawdown characteristics.