PT  - JOURNAL ARTICLE
AU  - Tarun Gupta
AU  - Jay Raol
AU  - Viorel Roscovan
TI  - Factor Investing: From Theory to Practice
AID  - 10.3905/jbis.2022.1.016
DP  - 2022 Oct 19
TA  - The Journal of Beta Investment Strategies
PG  - jbis.2022.1.016
4099  - https://pm-research.com/content/early/2022/10/19/jbis.2022.1.016.short
4100  - https://pm-research.com/content/early/2022/10/19/jbis.2022.1.016.full
AB  - Although factor investing has become an industry standard, the debate over which factors drive the risk and return of various asset classes across the globe is ongoing. The literature documents more than 400 of such factors claiming to deliver an attractive risk and return trade-off. Although promising, this research also imposes a heavy burden on practitioners who seek to identify the true factors that can help generate ongoing investment returns in excess of benchmarks. Modern multiple-testing techniques proposed by academics typically fall under traditional hypothesis testing and can generally be summarized as imposing more-stringent statistical thresholds for factor premiums to satisfy. In addition, such statistical techniques may ignore prior economic beliefs that investors might have that are important for the optimal design of investment strategies. This article proposes a parsimonious yet rigorous paradigm for practitioners to determine factor existence by focusing on economic theory alongside robust empirical evidence and incorporating real-world implementation considerations. The main goal of the framework is to guide practitioners in factor selection while designing investment strategies that can maximize the probability of generating ongoing investment performance. The authors apply this framework for value, momentum, quality, low-volatility, and size factors in equity and fixed-income markets across the globe. They find compelling evidence for value, momentum, quality, and low-volatility factors, but not the size factor. Their framework can be readily extended to evaluate broad factor categories across different asset classes, alternative factor signals, or additional investment constraints.