Factors vs. Sectors in Asset Allocation: Stronger Together?
24 Pages Posted: 10 May 2017 Last revised: 27 May 2018
Date Written: September 9, 2017
This paper compares and contrasts factor investing and sector investing, and then seeks a compromise by optimally exploiting the advantages of both styles. Our results show that sector investing is effective for reducing risk through diversification while factor investing is better for capturing risk premia and so pushing up returns. This suggests that there is room for potentially fruitful combinations of the two styles. Presumably, by combining factors and sectors, investors would benefit both from the diversification potential of the former and the risk premia of the latter. The tests reveal that composite strategies are particularly attractive; they confirm that sector investing helps reduce risks during crisis periods, while factor investing can boost returns during quiet times.
Keywords: investment, asset allocation, factor, industry, sector, crisis
JEL Classification: G11, G01, C58, D92
Suggested Citation: Suggested Citation