Is there a factor bubble? Tabulating papers in the top finance journals, nearly 250 factors appear to provide excess returns. In the last few years, researchers have discovered roughly 40 new factors each year (Harvey, Liu, and Zhu, 2014). There were only five factors in the 1990s!
No doubt we are witnessing a factor bubble, which is perhaps not surprising given the unprecedented “printing” of diplomas for financial engineers engaged in business schools globally! These financial engineers, whose career trajectory depends in no small part on identifying new factors, have in turn conducted an unprecedented number of backtests, mining for artifacts in historical return data. Unfortunately, this factor proliferation has been transmuted into product proliferation, particularly in the smart beta area. And investors considering multifactor strategies are absolutely overwhelmed. Which of the 250 factors are reliable? Which are most likely to provide excess returns in the future? As it turns out, most of the factors are not persistent – including a few well-known ones like small-cap and quality.
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