Rational – Rational for multi-factor approaches

 

Successful active equity strategies can often be explained by exposures to a set of well-documented factors. Taking these factor exposures into account, active returns can eventually be fully explained. This has led to the construction of single factor-indices (size, value, quality, dividend, etc.).

But even if the factors to which these indices are exposed to are well rewarded in the long run, they often encounter prolonged periods of underperformance. Hence the reward of exposure to individual factors has been shown to vary over time.

Assuming that the returns of distinct factors are not correlated, allocation across factors permits to diversify the sources of outperformance thus smoothing their performance across market cycles.