Factor investing is a simple concept. Put simply, factor exposures drive the performance of diversified portfolios. With a construction technique that furnishes the ability to achieve precise and controlled factor exposures, it is possible to readily construct factor strategies—and their opposites—in a transparent manner.
Some key points in this paper include:
- Stock weighting schemes in a portfolio have a profound effect on factor exposures and, hence on the portfolio performance. Popular weighting schemes create unintended and potentially undesirable factor exposures.
- Mere inversion of the stock weights of a portfolio does not invert a portfolio’s factor exposures. Using a factor tilting methodology, we demonstrate that it is possible to produce portfolios with precisely opposite factor exposures.
- The magnitude of the factor exposures has a direct impact on the portfolio performance outcomes.
- Factor exposures resulting from the interaction of stock selection and stock weighting schemes explains the phenomenon of Malkiel’s Monkey portfolio.
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