Factor Investing for the Long Run

Abstract

Anomaly-based investment/pricing factors are typically built from portfolios double-sorted on size and one additional characteristic, applying simple long/short fixed-weights schemes. Characteristic-based portfolios show significant time variations of their abnormal returns and market exposures. While timing abnormal returns is challenging, a long-term risk-averse investor benefits from implementing dynamic weighting schemes that account for the market exposures of the portfolios and their time-variation. Particularly for long investment horizons, significant out-of-sample Sharpe ratio improvements and utility gains with respect to fixed-weights factor benchmarks are recorded using portfolios sorted on size, value, operating profitability, investment and momentum.

Keywords: Factor investing, Market anomalies, Dynamic asset allocation, Portfolio choice, Return predictability, Stochastic volatility

JEL Classification: G11, G12, E32, G17