Tradable Risk Factors for Institutional and Retail Investors

Abstract

We construct tradable, long-short risk factors using combinations of large and liquid mutual funds (long leg) and ETFs (long and short legs), based on their holdings, for both retail and institutional investors. Exploiting a novel dataset, our tradable factors explicitly take into account ETF shorting costs and the capacity constraints of factor strategies. The tradable risk factors constitute valid benchmarks to evaluate portfolio managers and trading strategies, and they perform differently from "on-paper" risk factors (2% to 5% per year) due to implementation frictions in the short leg.

Keywords: Smart beta, factor investing, tradable factors, shorting costs, borrowing fees

JEL Classification: G11, G12