Why Are High Exposures to Factor Betas Unlikely to Deliver Anticipated Returns?

Abstract

By choosing investment strategies that intentionally create exposure to factor betas, investors may be obtaining uncompensated risks. We show across a wide variety of factors and geographical markets that factors constructed from fundamental characteristics have earned high returns, whereas those constructed from statistical betas have earned returns close to zero. When designing factor-based investment strategies, investors should seek exposure to the fundamental characteristics that define a factor and use statistical measures of factor betas to manage factor risks. Conversely, seeking to gain exposure to factor betas is a misguided means of obtaining the returns available from factor investing.

Keywords: Factor Portfolios, Risk Factors, Characteristics, Covariances

JEL Classification: G00, G11, G12, G40