To make the most of factor investing, understanding how factors work and interact is key. In this research paper, we explain why efficient factor investing requires an understanding of how factor characteristics drive portfolio returns.
Using a characteristics-based multi-factor return model, we analyze the performance of factor-based equity portfolios and show that generic single-factor portfolios are sub-optimal as they ignore the possibility that they may be unattractive from the perspective of other factors. We also show that differences in performance between integrated and mixed-sleeve multi-factor portfolios, small-cap and large-cap factor portfolios, and equal and value-weighted factor portfolios can be fully attributed to the differences in their factor characteristics.
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