Practical Applications of Asset Allocation and Factor Investing: An Integrated Approach

Practical Applications Summary

In recent years, management of multi-asset portfolios has shifted away from conventional “asset allocation” approaches toward what might loosely be termed “risk allocation” methodologies, or “factor investing.” The factor-oriented approach presents its own set of challenges, say Mark Kritzman (Windham Capital Management and MIT Sloan School of Management), Alain Bergeron, and Gleb Sivitsky (both of Mackenzie Investments). Asset Allocation and Factor Investing: An Integrated Approach, published in the 2018 Quantitative Special Issue of The Journal of Portfolio Management, highlights some of these challenges, such as the “mapping risk” between factors (e.g., inflation or growth) and assets (e.g., bonds or equities). To preserve the virtues of both asset allocation and factor investing while minimizing their pitfalls, the authors propose a model for integrating factors with a traditional asset allocation methodology. Although the authors demonstrate their model using the macro-based factors of growth and inflation, the model could also be used to integrate views on security-based risk premia such as value, momentum, and low volatility.

TOPIC: Portfolio construction