Factor optimization approach
A method of implementation according to which a portfolio is fully allocated to factors.
Here, traditional investment strategies are replaced entirely with the factor approach*. Allocation takes place over the full range of asset classes.
The research paper: 'Factor Investing in Practice: A Trustees' Guide to Implementation' (2014), distinguishes three methods of implementing factor investing. In addition to the factor optimization approach described here, these are the risk due diligence approach (page 32) and the use of factor tilts (page 20).
The adjoining illustration shows a traditional portfolio with allocation to asset classes (equities and corporate or government bonds). In the case of a full factor approach, the portfolio is constructed with attractive factors.
* Robeco takes a balanced approach to equities that ensures diversification and exposure to the principal factor premiums, such as the so-called 1/n solution.
Figure: Traditional portfolio versus the factor investing approach
Source: Robeco Investment Solutions 2014