The institutional asset management industry is shifting to a new paradigm. Several large institutions have recently modified their strategic allocations by changing from a traditional asset allocation approach, in which diversification occurs by explicitly allocating to several asset classes and regions, towards a factor allocation approach, in which diversification occurs by explicitly allocating to different factor premiums. As such factor investing entails allocating to factors shown to have a premium.
Academic research shows that factor premiums have better risk/return profiles than market-capitalization weighted indices. Several well-known factor premiums in the equities are, e.g., the low-volatility premium (Blitz and van Vliet, 2007), the size premium (Banz, 1981), the value premium (Fama and French, 1992) and the momentum premium (Jegadeesh and Titman, 1993). Factor premiums are not only present within equities, but also within other asset classes. For instance, the low volatility effect is also present in credits (see, e.g., Houweling et al., 2012) while value and momentum also exists in bonds and commodities (see, e.g., Asness, Moskowitz and Pedersen, 2009).
While factor premiums are certainly becoming more and more popular among investors, the interplay between different factor premiums (like, value, momentum, low volatility, and quality) is not yet clearly uncovered. One reason for this gap in the literature might be related to the limited ability of standard statistical tools to pinpoint the determinants of the relationship between the existing premiums. Interestingly, new set of tools are becoming more popular to analyze such big data problems. In this project, we aim at analyzing the relationship between factor premiums using big data and machine learning algorithms.
For a short introduction to Factor Investing, please watch our animation:
Ang, A., W. Goetzmann, and S. Schaefer, 2009. “Evaluation of Active Management of the Norwegian Government Pension Fund Global”. Available at http://www.regjeringen.no
Asness C., T. Moskowitz, and L. Pedersen, 2009. “Value and Momentum Everywhere”. NBER Working Paper
Banz, R., 1981. “The Relationship between Return and Market Value of Common Stocks”. Journal of Financial Economics, 9, 3-18.
Blitz, D., 2011. “Strategic Allocations to Premiums in the Equity Market”.
Blitz, D., and P. Van Vliet, 2007. “The Volatility Effect”. Journal of Portfolio Management
Fama, E., and K. French, 1992. “The Cross-Section of Expected Stock Returns”. Journal of Finance, 47, 427-465.
Jegadeesh, N., and S. Titman, 1993. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency”. Journal of Finance, 48, 65-91.