Factor-Investing and Asset Allocation Strategies: A Comparison of Factor Versus Sector Optimization

Abstract

Given the tremendous growth of factor allocation strategies in active and passive fund management, we investigate whether either asset allocation strategies based on factors or sectors provide investors with a superior portfolio performance. Our focus is on comparing factor versus sector allocation as some recent empirical evidence indicates the dominance of sector over country portfolios. We analyze the performance and performance differences of sector and factor portfolios for various weighting and portfolio optimization approaches including ‘equal-weighting’ (1/N), ‘risk-parity’ (RP), minimum-variance (MinVar), mean-variance (MV), Bayes-Stein (BS) and Black-Litterman (BL) by employing a sample-based approach in which the sample moments are the input parameters for the allocation model. For the period from May 2007 to November 2020, our results clearly reveal that, over longer investment horizons, factor portfolios provide relative superior performances. For shorter periods, however, we observe time varying and alternating performance dominances as the relative advantage of one over the other strategy depends on the economic cycle. We find that during “normal” times factor portfolios clearly dominate sector portfolios, whereas during crisis periods sector portfolios are superior offering better diversification opportunities.

Keywords: Asset Allocation, Portfolio Optimization, Factor-investing, Factor vs. Sector Allocation

JEL Classification: G17, G11, C53