Practical Applications of Not All Factor Exposures Are Created Equal

Practical Applications Summary

In Not All Factor Exposures Are Created Equal, from the 2018 Quantitative Special Issue of The Journal of Portfolio Management, authors Eric Sorensen, Mark Barnes, Nick Alonso, and Edward Qian (all of PanAgora Asset Management in Boston, MA) evaluate the use of different portfolio construction methodologies for managing factor portfolios. They consider four types of portfolios that hold the factor exposure constant and have varying security weighting schemes: factor weighted (FW), cap weighted (CW), equal weighted (EW), and risk parity weighted (RP). The find that using a risk-aware weighting scheme exemplified by their RP portfolios  generally achieves both strong upside participation and an advantageous defensive posture when a factor underperforms. They ascribe the advantage of the RP approach to sector positions, particularly in emphasizing exposure to defensive sectors such as consumer staples, healthcare, and utilities.

TOPICS: Factor-based models, portfolio construction