Practical Considerations for Factor-Based Asset Allocation

Abstract

Much has been written about the shortcomings of the traditional approach to asset allocation. Traditional asset allocation policies can be characterized by relatively static asset allocation and by diversification across asset class building blocks. Exactly how risk factors should be included in the portfolio construction process is still a nascent area of research and is fiercely debated among practitioners. Although numerous research papers explore this topic, they tend to be theoretical, and for this reason, this article has a stronger focus on the practical aspects of implementation. Rather than provide definitive answers here, the authors aim to share their reflections on this topic, following feedback from practitioners and discussions that took place in client roundtable events organized by S&P Dow Jones Indices to promote dialogue with industry experts.

TOPICS: Portfolio theory, factor-based models, portfolio construction