Is Sector-neutrality in Factor Investing a Mistake?

42 Pages Posted: 10 Nov 2021 Last revised: 8 Aug 2023

See all articles by Sina Ehsani

Sina Ehsani

Northern Illinois University

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Feifei Li

Research Affiliates, LLC

Date Written: February 22, 2022

Abstract

Stock characteristics have two sources of predictive power. First, a characteristic might be valuable in identifying high or low expected returns across industries. Second, a characteristic might be useful in identifying individual stock expected returns within an industry. Past studies generally find that the firm-specific component is the strongest predictor, leading many to sector neutralize their factor exposures. We show both analytically and empirically that the average long–short investor is more likely to benefit from hedging out sector bets, whereas the long-only investor should, on average, avoid sector neutralization.







Citation: Ehsani, Sina and Harvey, Campbell R. and Li, Feifei, Is Sector-Neutrality in Factor Investing a Mistake? Financial Analysts Journal, 2023, 79(3): 95–117. DOI: 10.1080/0015198X.2023.2196931.

Keywords: Sector neutralization, industry factors, equity factors, sector neutral, sector bet, sector tilt, factor zoo, portfolio management, smart beta

JEL Classification: G11, G12, G15, M41

Suggested Citation

Ehsani, Sina and Harvey, Campbell R. and Li, Feifei, Is Sector-neutrality in Factor Investing a Mistake? (February 22, 2022). Available at SSRN: https://ssrn.com/abstract=3959116 or http://dx.doi.org/10.2139/ssrn.3959116

Sina Ehsani

Northern Illinois University ( email )

Chicago, IL 60115
United States

Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)

HOME PAGE: http://www.duke.edu/~charvey

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Feifei Li

Research Affiliates, LLC ( email )

620 Newport Center Dr
Ste 900
Newport Beach, CA 92660
United States
949-325-8753 (Phone)
949-325-8953 (Fax)

HOME PAGE: http://researchaffiliates.com/index.htm

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