Abstract
AbstractDespite extensive research support, the role of diversification in current factor investing strategies remains neglected. This paper investigates whether well-designed multifactor portfolios should not only be based on firm characteristics, but should also include portfolio diversification effects. While the alpha concentration approach mainly considers factor-specific firm characteristics, the diversified approach utilizes covariance estimators in addition to firm characteristics to account for portfolio diversification. The corresponding out-of-sample results show that including an efficient covariance estimator improves the performance of long-only multifactor portfolios compared to the pure alpha concentration approach. A particular advantage of diversified factor investing strategies can be identified in the significant increase in exposure to the low-volatility factor represented by firm characteristics with high informational content. No significant performance differences are observed for long-short portfolios where the factor exposures of the alpha concentration and diversification approaches are similar with respect to the low-volatility factor.
Funder
Europa-Universität Viadrina Frankfurt (Oder)
Publisher
Springer Science and Business Media LLC
Subject
Information Systems and Management,Strategy and Management,Business and International Management
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