Clash of the Titans: Factor Portfolios vs Alternative Weighting Schemes
The Journal of Portfolio Management Quantitative Special Issue 2019, http://jpm.pm-research.com/content/45/3/38
Posted: 20 May 2019
Date Written: December 1, 2018
Abstract
In this paper, the authors (re) introduce mean-variance portfolio construction for factor portfolios. These models, first popular with quants in the 1990s, are being resurrected today in a different context for transparent factor portfolios. The authors then evaluate the merits of these mean-variance factor portfolios against alternative weighting schemes. They point out that alternative weighting schemes have arguably weak theoretical foundations and their supporters rationalize them with a range of (very different) reasons, most of them dis-satisfying in the view of the authors. They then show that alternative weighting schemes derive a large part of their outperformance from a handful of well-known factors. The authors argue that sensibly built factor portfolios deliver similar or higher information ratio by explicitly harnessing the factors, and doing so in an efficient risk- and transaction cost-aware way.
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