@article {Amenc64, author = {No{\"e}l Amenc and Fr{\'e}d{\'e}ric Ducoulombier and Felix Goltz and Ashish Lodh and Sivagaminathan Sivasubramanian}, title = {Diversified or Concentrated Factor Tilts?}, volume = {42}, number = {2}, pages = {64--76}, year = {2016}, doi = {10.3905/jpm.2016.42.2.064}, publisher = {Institutional Investor Journals Umbrella}, abstract = {The authors compare two approaches to single-factor index design: concentrated and diversified indices. From a conceptual perspective, the authors emphasize several issues with highly concentrated portfolios. Concentration in a few stocks reflects high confidence in the precision of the link between expected returns and factor exposure, whereas expected returns are notoriously difficult to estimate precisely. Moreover, the empirical asset-pricing literature emphasizes the need to construct broad portfolios that are not unduly influenced by a small number of stocks. The authors{\textquoteright} empirical analysis compares broader and more narrow stock selections, as well as two different weighting schemes, equal-weighting and cap-weighting. Their results show that concentrated factor-tilted portfolios come with problems. Trying to improve a cap-weighted factor-tilted portfolio{\textquoteright}s performance by selecting fewer stocks that are most strongly tilted to the factor does not have any effect on risk-adjusted performance. With concentration, returns and risk increase. However, concentration leads to problems such as higher turnover, high idiosyncratic risk, and longer times to trade. Conversely, achieving concentration through a move to equal-weighing leads to higher Sharpe and information ratios, with only marginally higher turnover levels.TOPICS: Analysis of individual factors/risk premia, factor-based models, portfolio construction}, issn = {0095-4918}, URL = {https://jpm.pm-research.com/content/42/2/64}, eprint = {https://jpm.pm-research.com/content/42/2/64.full.pdf}, journal = {The Journal of Portfolio Management} }