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How to build a factor portfolio: Does the allocation strategy matter?

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  • Hubert Dichtl
  • Wolfgang Drobetz
  • Viktoria‐Sophie Wendt

Abstract

Factor‐based allocation embraces the idea of factors, as opposed to asset classes, as the ultimate building blocks of investment portfolios. We examine whether there is a superior way of combining factors in a portfolio and provide a comparison of factor‐based allocation strategies within a multiple testing framework. Factor‐based allocation is profitable beyond exploiting genuine risk premia, even when applying multiple testing corrections. Investment portfolios can be efficiently diversified using factor‐based allocation strategies, as demonstrated by robust economic performance over various economic scenarios. The naïve equally weighted factor portfolio, albeit simple and cost‐efficient, cannot be outperformed by more sophisticated allocation strategies.

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  • Hubert Dichtl & Wolfgang Drobetz & Viktoria‐Sophie Wendt, 2021. "How to build a factor portfolio: Does the allocation strategy matter?," European Financial Management, European Financial Management Association, vol. 27(1), pages 20-58, January.
    • Handle: RePEc:bla:eufman:v:27:y:2021:i:1:p:20-58
    DOI: 10.1111/eufm.12264
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