Academic Insights on Investing

Weekly Academic Insight: Fundamentals of Efficient Factor Investing


Authors:             R. CLARKE, H. DE SILVA, and S. THORLEY

Publication:       FINANCIAL ANALYST JOURNAL • VOL. 62 • DECEMBER 2016

#Research Question:  Is a long only constrained-investor, with views about equity market factor returns, better off with a combination of factor portfolios or with a portfolio of individual securities exposed to the desired factors?

#Academic Insight:   Portfolios built directly from individual securities capture most of the potential gain (80%) from exploiting a small set of factors whereas combinations of specialized factor portfolios capture only a fraction (40%) of that potential.

#Application:    Investors who have the resources and capabilities are better off gaining exposure to factors, within the equity asset class, directly from individual securities rather than from pre-packaged multi-factor solutions.  One caveat: if a pre-packaged portfolio measures all the factors that the end investor views as relevant or desirable, it would serve as an appropriate substitute.