Multi-factor index fund allocations are increasingly becoming the preferred approach to factor investing. In this paper, we examine the return/risk characteristics of nine static and dynamic weighting strategies over a 36-year period. The results highlight that a simple strategy that equal weights multiple factor indexes has historically proved more effective than many of the more complex approaches — pointing to its potential as a way to combine factors, especially in the absence of active investment views and skills. However, a dynamic factor weighting strategy based on fundamental signals also has merit if the investor believes she has the insight or skills required.
• A simple equal-weighted strategy has been highly effective historically. Many simple rules-based and optimization-based dynamic weighting strategies have failed to match its performance after accounting for turnover cost.
• Fundamentals-based approaches have produced attractive risk-adjusted returns in simulation. The three strategies tested here have delivered higher active returns against the equal-weighted strategy, highlighting the potential benefits of exploiting fundamental insights in the construction of a multi-factor index. Such strategies, however, are active in nature and typically come with the extra costs of higher turnover and greater complexity.
• As investors explore multi-factor investing, the equal-weighted strategy index — which we call Simple Diversification — brings simplicity, transparency and robustness to the investment process and can serve as an attractive starting point for factor allocation.
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