- The debate goes on about the best way to construct a multi-factor index: a “mixed” composite of individual factors versus an “integrated,” bottom-up approach of simultaneous factor exposures.
- In this Insights, we empirically show that the FTSE Russell “tilt-tilt” integrated methodology is more capital efficient in delivering exposures than a mixed composite methodology.
- We show that the capital efficiency of the tilt-tilt methodology is equivalent to using leverage in a composite approach.
There has been a lively debate amongst practitioners about the most capital efficient method of building a multi-factor portfolio. By “capital efficient,” we mean the most cost effective way to achieve a given level of factor exposures and the factor premiums accessed by those exposures. Achieving a level of factor exposures for less means that more capital can be allocated to other targeted strategies or provide a better allocation of the fee budget. The debate centers on comparing a top-down composite mix of individual factors versus a bottom-up fully integrated portfolio of stocks that are simultaneously exposed to the target factors.
In this paper we use index data dating back to 1997 to demonstrate the capital efficiency of the tilt-tilt methodology. The example indexes all use the same methodology for constructing individual factors, which eliminates one confounding issue caused by comparing indexes from different providers who calculate single factors differently from one another. By focusing on the delivery of factor exposures, not returns, the additional confounding issue of individual factor return cycles is also eliminated as exposures tend to be more stable over time than factor returns.
Read the complete white paper at the link beneath Related Files