PT  - JOURNAL ARTICLE
AU  - Ashley Lester
TI  - On the Theory and Practice of Multifactor Portfolios
AID  - 10.3905/jpm.2019.45.3.087
DP  - 2019 Feb 28
TA  - The Journal of Portfolio Management
PG  - 87--100
VI  - 45
IP  - 3
4099  - https://pm-research.com/content/45/3/87.short
4100  - https://pm-research.com/content/45/3/87.full
AB  - Investors interested in factor investing often seek exposure to several factors, not just one or two. The decision on how to implement multiple exposures may have a considerable effect on performance. In this article, the author considers the investment choice between a set of single-factor subportfolios and a single integrated portfolio. He defines factor exposures in a way that precisely relates relative factor exposures to the number and correlation of factors and predicts analytically consequent changes in risk and return. Theoretically, integrated portfolios increasingly outperform segregated portfolios when the number of factors is large and average correlation is low. He tests his predictions by generating over 1,000 matched pairs of historical portfolios using a wide range of factor definitions. This contrasts with the existing literature, which typically focuses on a handful of portfolios using particular versions of factors. The empirical results strongly support the theoretical predictions. In practical terms, an integrated portfolio of four orthogonal factors generates twice the factor exposure of the corresponding set of single-factor portfolios, twice the outperformance, and a 40% higher information ratio.TOPICS: Portfolio construction, style investing, factor-based models