Tradable Risk Factors for Institutional and Retail Investors

Abstract

We construct tradable risk factors using combinations of large and liquid mutual funds (long leg) and ETFs (long and short legs), based on their holdings, for both retail and institutional investors. Exploiting a novel dataset, our tradable factors take into account ETF shorting costs. Assessing the performance of our tradable factors against standard “on-paper” factors, we uncover an implementation shortfall of 2%-4% annually. Shorting fees and transaction costs contribute to 58% of the performance differential between tradable and “on-paper” factors, assigning a non-trivial role to the opportunity cost of not trading the exact “on-paper” portfolio.

Keywords: Smart beta, factor investing, tradable factors, shorting costs, borrowing fees

JEL Classification: G11, G12