Smart Beta Multi-Factor Construction Methodology: Mixing vs. Integrating

Journal of Index Investing, vol. 8, no. 4 (Spring 2018)

Posted: 25 Sep 2017 Last revised: 30 Nov 2018

See all articles by Tzee-man Chow

Tzee-man Chow

Research Affiliates, LLC

Feifei Li

Research Affiliates, LLC

Joseph (Yoseop) Shim

Research Affiliates, LLC

Date Written: September 21, 2017

Abstract

The authors compare the qualitative properties as well as the risk and return profiles of simulated multi-factor portfolios constructed in accordance with two different methodologies. The first, the integrating approach, is a process that searches the universe for securities that have exposures to various target factors and selects the ones with the highest composite scores. The second, the mixing approach, achieves the desired exposure to multiple factors by allocating assets across single-factor portfolios. The authors tested portfolios designed to capture value, momentum, profitability, investment, and low-beta factor premia. Integrating outperformed mixing absolutely and on a risk-adjusted basis. The integrating strategy, however, proved to have higher concentration and turnover, resulting in idiosyncratic active risk and estimated transaction costs that reduced its return advantage over the mixing strategy. In addition, the mixing approach offers the practical benefits of transparency, flexibility, and ease of performance attribution. These features make mixing a viable choice, especially for investors and practitioners in a principal/agent relationship.

Keywords: smart beta, multi-factor portfolios, integrating, mixing

JEL Classification: G10

Suggested Citation

Chow, Tzee-man and Li, Feifei and Shim, Joseph (Yoseop), Smart Beta Multi-Factor Construction Methodology: Mixing vs. Integrating (September 21, 2017). Journal of Index Investing, vol. 8, no. 4 (Spring 2018). Available at SSRN: https://ssrn.com/abstract=3041411 or http://dx.doi.org/10.2139/ssrn.3041411

Tzee-man Chow (Contact Author)

Research Affiliates, LLC ( email )

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Feifei Li

Research Affiliates, LLC ( email )

620 Newport Center Dr
Ste 900
Newport Beach, CA 92660
United States
949-325-8753 (Phone)
949-325-8953 (Fax)

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Joseph (Yoseop) Shim

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States
949-325-8723 (Phone)

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