Factor-Based Investing

60 Pages Posted: 8 Mar 2016  

Pim Lausberg

APG Asset Management; VU University Amsterdam - Faculty of Economics and Business Administration

Alfred Slager

Tilburg University - TIAS School for Business and Society

Philip A. Stork

VU University Amsterdam - Faculty of Economics and Business Administration; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)

Date Written: March 7, 2016

Abstract

The asset management industry has seen a strong development of factor-based investing. The central idea is that each asset can be seen as a bundle of underlying factor sensitivities. A factor-based investing approach provides better insight into the risk decomposition of the investment portfolio’s assets and potentially leads to better investment decision-making.

In this paper we explore how investors should take account of underlying factors driving their portfolio returns. We show that underlying factors explain the majority of return variation among assets. We find there are times that a given factor sensitivity offers exceptionally high or low rewards in all assets exposed to it. These circumstances lead to an opportunity for market timing.

We propose a pragmatic and intuitive approach for identifying and measuring underlying factors in a portfolio via a heat map. We argue that investors seeking to adopt a factor-based approach use it in conjunction with traditional asset allocation, rather than as a substitute. In addition, we provide suggestions on how to embed the factor-based approach within an existing investment process.

Finally, a word about our relationship with ABN AMRO. The research project on factor-based investing is part of ABN AMRO Private Banking’s continuous process to challenge, and thereby to improve the investment process with new insights in the financial markets and investment approaches. Therefore we were given the task of writing this report.

Keywords: Factor Investing, European Data, Optimization, Timing

JEL Classification: G11, G12, G15, G23

Suggested Citation

Lausberg, Pim and Slager, Alfred and Stork, Philip A., Factor-Based Investing (March 7, 2016). Available at SSRN: https://ssrn.com/abstract=2743574 or http://dx.doi.org/10.2139/ssrn.2743574

Pim Lausberg (Contact Author)

APG Asset Management ( email )

Gustav Mahlerplein 3
Amsterdam, 1082 MS
Netherlands

VU University Amsterdam - Faculty of Economics and Business Administration

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands

Alfred Slager

Tilburg University - TIAS School for Business and Society ( email )

Warandelaan 2
TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

Philip A. Stork

VU University Amsterdam - Faculty of Economics and Business Administration ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Tinbergen Institute - Tinbergen Institute Amsterdam (TIA) ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Paper statistics

Downloads
624
Rank
32,448
Abstract Views
1,379