Can the Whole Be More Than the Sum of the Parts? Bottom-Up Versus Top-Down MultiFactor Portfolio Construction

Posted: 21 May 2019

See all articles by Jennifer Bender

Jennifer Bender

State Street Global Advisors

Taie Wang

State Street Global Advisors

Date Written: February 6, 2016

Abstract

Rules-based factor portfolios combining multiple factors have become increasingly popular in recent years. One often-asked question concerning portfolio construction is whether combining individual factor portfolios is equivalent to building a bottom-up multi-factor portfolio. The latter has theoretical merit since each security’s weight in the portfolio will depend on how well it ranks on multiple factors simultaneously. The former approach may miss cross-sectional interaction effects between how factors express themselves at the security level. The authors analyze the magnitude of these effects here and find that these interaction effects can in fact have a significant impact on portfolio performance. Both intuition and empirical evidence favor bottom-up multi-factor portfolio construction.

Keywords: Factor Portfolios, Bottom-Up Construction, Blending Portfolios

Suggested Citation

Bender, Jennifer and Wang, Taie, Can the Whole Be More Than the Sum of the Parts? Bottom-Up Versus Top-Down MultiFactor Portfolio Construction (February 6, 2016). https://doi.org/10.3905/jpm.2016.42.5.039. Available at SSRN: https://ssrn.com/abstract=3080357 or http://dx.doi.org/10.2139/ssrn.3080357

Jennifer Bender (Contact Author)

State Street Global Advisors ( email )

1 Lincoln Street
28th Floor
Boston, MA 02111
United States

Taie Wang

State Street Global Advisors ( email )

68/F, Two International Finance Centre
8 Finance Street, Central
Hong Kong, Hong Kong
Hong Kong

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