Transaction Costs of Factor Investing Strategies
Financial Analysts Journal, Spring 2019, Forthcoming
40 Pages Posted: 22 Apr 2019
Date Written: November 30, 2018
Although hidden, implicit market impact costs of factor investing strategies may substantially erode the strategies' expected excess returns. The authors explain these market impacts costs and model them using rebalancing data of a suite of large and longstanding factor investing indices. They introduce a framework to assess the costs of rebalancing activities, and attribute these costs to characteristics such as rate of turnover and the concentration of turnover, which intuitively describe the strategies' demands on liquidity. The authors evaluate a number of popular factor-investing strategy implementations and identify how index construction methods, when thoughtfully designed, can reduce market impact costs.
Keywords: factor investing, smart beta, transactions costs, implementation costs, implicit market impact cost, market impact cost model, capacity
JEL Classification: G00
Suggested Citation: Suggested Citation