Index + Factors + Alpha

47 Pages Posted: 6 Oct 2020 Last revised: 15 Mar 2021

See all articles by Andrew Ang

Andrew Ang

BlackRock, Inc

Linxi Chen

BlackRock, Inc

Michael D Gates

BlackRock, Inc - San Francisco

Paul Henderson

BlackRock, Inc

Date Written: March 12, 2021

Abstract

We establish, under both theoretical conditions and empirical application, the separate roles of (1) market asset class exposure through index funds; (2) style factor exposure like value, momentum, and quality which have traditionally delivered higher and differentiated returns than market index exposure; and (3) pure alpha-seeking sources of return in excess of index and factor returns. We develop a new methodology to determine optimal allocations of index, factors, and alpha-seeking funds by imposing priors on the information ratios of factors and alpha strategies. We expect in most cases, prior standard deviations for factor funds should be smaller than alpha strategies, given the economic rationale and relatively long histories of factor strategies. The means and covariances from the predictive distribution can be used as inputs in standard optimization procedures.

Suggested Citation

Ang, Andrew and Chen, Linxi and Gates, Michael D and Henderson, Paul, Index + Factors + Alpha (March 12, 2021). Available at SSRN: https://ssrn.com/abstract=3689707 or http://dx.doi.org/10.2139/ssrn.3689707

Andrew Ang

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Linxi Chen (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States
9197682272 (Phone)

Michael D Gates

BlackRock, Inc - San Francisco ( email )

400 Howard Street
San Francisco, CA 94105
United States

Paul Henderson

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

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