RT Journal Article SR Electronic T1 Accounting for Cross-Factor Interactions in Multifactor Portfolios without Sacrificing Diversification and Risk Control JF The Journal of Portfolio Management FD Institutional Investor Journals SP 99 OP 114 DO 10.3905/jpm.2017.43.5.099 VO 43 IS 5 A1 Noël Amenc A1 Frédéric Ducoulombier A1 Mikheil Esakia A1 Felix Goltz A1 Sivagaminathan Sivasubramanian YR 2017 UL https://pm-research.com/content/43/5/99.abstract AB 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.TOPICS: Portfolio construction, analysis of individual factors/risk premia, VAR and use of alternative risk measures of trading risk