Factor Investing: Get Your Exposures Right!

29 Pages Posted: 26 Nov 2018

See all articles by François Soupé

François Soupé

BNP Paribas Asset Management

Lu Xiao

BNP Paribas Investment Partners

Raul Leote de Carvalho

BNP Paribas Asset Management

Date Written: October 26, 2018

Abstract

This paper is devoted to the question of optimal portfolio construction for equity factor investing. The first part of the paper focusses on how to make sure that a given equity portfolio has the targeted factor exposures, even before imposing any constraints. We show that such portfolios can be derived from mean-variance optimization using stock expected returns as inputs provided these are built in a robust way from information about the factors. We propose a framework to build those robust stock expected returns and show that the targeted factor exposures are retained by the portfolios both before and after applying realistic constraints, e.g. long-only. Other more simplistic approaches fail. In the second part of the paper we illustrate the application of the framework to a practical case where the objectives are, first, to decide about the risk budget allocation to factors in some pragmatic way; and second, to construct a long-only constrained portfolio that retains the targeted exposures to four factors from well-known asset pricing equity models, namely High-minus-Low (HML), Robust-minus-Weak (RMW), Conservative-minus-Aggressive (CMA) and Momentum (MOM).

Keywords: Factor investing, Portfolio Optimization, Robust Optimization, Mean-variance Optimization, Smart Beta, Black-Litterman

JEL Classification: G11

Suggested Citation

Soupé, François and Xiao, Lu and Carvalho, Raul Leote de, Factor Investing: Get Your Exposures Right! (October 26, 2018). Available at SSRN: https://ssrn.com/abstract=3276006 or http://dx.doi.org/10.2139/ssrn.3276006

François Soupé

BNP Paribas Asset Management ( email )

14 rue Bergere
Paris, 75009
France

Lu Xiao

BNP Paribas Investment Partners ( email )

14 rue bergère
Paris, 75009
France

Raul Leote de Carvalho (Contact Author)

BNP Paribas Asset Management ( email )

14 rue Bergere
Paris, 75009
France
0033158972183 (Phone)

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