Effective Factor Management with Analytical Precision

Abstract

Factors are popular handles on which portfolio and risk managers can express investment and risk views. In the equity world, portfolio managers (PM) often face the dilemma of trading off intentional factor tilts against unintentional factor skews. For example, a Banks tilt generates an unintentional exposure to Credit Risk, and a Value style has a built-in Size bias, etc. Traditional mitigation often resorts to ad hoc manual adjustments without a consistent theoretical ground and analytical control. In this article, we introduce an integrated yet transparent framework for effective factor management. This paper features 15 worked examples, including the generation of:

- Dollar-neutral, Size-neutral Value factor portfolio;

- Dollar-neutral, Size-neutral composite Value and Long-Term momentum factor portfolio;

- 130/30 strategy with dollar-neutral, Size-neutral composite Value and Long-Term momentum factor tilt;

- Long-only 130/30 strategy with dollar-neutral, Size-neutral composite Value and Long-Term momentum factor tilt;

- Beta-neutral Value style; and

- Beta-neutral Value style with disciplined factor sensitivities.

Keywords: factor mimicking, factor combination, view blending and shrinkage, signal-noise efficiency, dollar neutrality, beta neutrality

JEL Classification: C10, C11, C61, G11