Navigating the Factor Zoo Around the World: An Institutional Investor Perspective
62 Pages Posted: 1 Jun 2020 Last revised: 17 Mar 2021
Date Written: December 29, 2019
The literature on cross-sectional stock return predictability has documented over 450 factors. We take the perspective of an institutional investor and navigate this zoo of factors by focusing on the evidence relevant to the practicalities of factor-based investment strategies. Establishing a sound theoretical rationale is key to identifying “true” factors, and we emphasize the need to recognize data-mining concerns that may cast doubt on the relevance of many factors. From a practical investment perspective, much of the factor evidence documented by academics may be more apparent than real. The performance of many factors is dependent on the inclusion of small- and micro-cap stocks in academic studies, although such stocks would likely be excluded from the real investment universe due to illiquidity and transaction costs. Nevertheless, a parsimonious set of factors emerges in equities and other asset classes, including currencies, fixed income and commodities. These factors can serve as meaningful ingredients to factor-based portfolio construction.
Keywords: Asset pricing, mispricing, risk factor, institutional investor, transaction costs, limits to arbitrage, market efficiency, anomaly
JEL Classification: G11, G12, G15
Suggested Citation: Suggested Citation