Equity Multi-Factor Approaches: Sum of Factors vs. Multi-Factor Ranking

Barclays Investment Strategies (QIS) Group (2016)

21 Pages Posted: 5 Nov 2018 Last revised: 26 Dec 2019

See all articles by Farouk Jivraj

Farouk Jivraj

Barclays Investment Bank; Imperial College Business School

David Haefliger

Barclays Investment Bank

Zein Khan

Barclays Investment Bank

Benedict Redmond

Barclays Investment Bank

Date Written: September 16, 2016

Abstract

There is a plethora of literature on the persistence and rationale of individual equity factor premia, which investors are often advised to extract through forming multi-factor portfolios – however, not so much attention is paid to the nuances of forming such portfolios and their implications.

There are generally two approaches for forming equity multi-factor portfolios:

- Sum of Factors (SoF) – where separate respective factor portfolios are first formed which are then subsequently combined.

- Multi-Factor Ranking (MFR) – where individual stocks are selected based on a specified multi-factor ranking model.

In this paper, we empirically demonstrate the implications of the two approaches when allocating across four equity factors: Value, Momentum, Low Volatility and Quality. We do so in the context of two topical implementation considerations:

- Portfolio size: Concentrated versus diversified portfolios.

- Factor exposure: Ex-ante versus ex-post factor exposure.

In summary when comparing the two approaches, we find:

- MFR portfolios have historically outperformed SoF portfolios irrespective of portfolio size.

- However, this has been historically driven by the persistently lower CAPM Beta of the MFR portfolios, which has not been by design and which is accentuated in concentrated portfolios.

- This lower CAPM Beta is from an implicit low volatility factor bias.

- Such a bias comes with performance risk implications that investors should be mindful of.

Keywords: smart beta; factors; portfolio construction

JEL Classification: G10; G11

Suggested Citation

Jivraj, Farouk and Haefliger, David and Khan, Zein and Redmond, Benedict, Equity Multi-Factor Approaches: Sum of Factors vs. Multi-Factor Ranking (September 16, 2016). Barclays Investment Strategies (QIS) Group (2016), Available at SSRN: https://ssrn.com/abstract=3260036

Farouk Jivraj (Contact Author)

Barclays Investment Bank ( email )

5 The North Colonnade
London, Canary Wharf E14 4BB
United Kingdom

Imperial College Business School ( email )

South Kensington campus
London, SW7 2AZ
United Kingdom

David Haefliger

Barclays Investment Bank ( email )

5 The North Colonnade
London, Canary Wharf E14 4BB
United Kingdom

Zein Khan

Barclays Investment Bank ( email )

5 The North Colonnade
London, Canary Wharf E14 4BB
United Kingdom

Benedict Redmond

Barclays Investment Bank ( email )

5 The North Colonnade
London, Canary Wharf E14 4BB
United Kingdom

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