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Factor Asset Allocation: What are the Benefits for Investors?

Factor investing is currently very popular among investors. This investment approach was developed following the publication of a report by Ang, Goetzmann and Schaefer (2009), who were asked to evaluate the performance of active management for Norway’s sovereign fund. According to the authors, risk factors are like nutrients, or building blocks, that explain the returns of various assets, which combine these building blocks. Those who believe in factor investing think that it is wiser to build a portfolio that bases its allocation on factors rather than on asset classes. In fact, asset classes are naturally correlated due to their underlying exposure to these common risk factors. For example, equity and high-yield corporate bonds are two asset classes with different degrees of exposure to equity risk, and are therefore highly correlated. Furthermore, this correlation between asset classes is amplified during crises, when market risk (or equity risk) starts to prevail over all other risks (Brière et al., 2012). This has led a large number of investors to question the conventional strategies for determining allocation based on asset classes and to focus more on methods that seek to diversify the sources of fundamental risk, or risk factors.

But what does «risk factor» mean? In theory, it is a «pure» exposure to an underlying risk that is supposed to produce a risk premium. In practice, there are a number of coexisting notions of factors: macroeconomic factors, statistical factors that result from principal component analysis (PCA) or other forms of analysis, «style» factors (size, value, momentum, etc.) that result from dynamic, systematic selection of individual securities (equity, or more recently corporate bonds), depending on their characteristics. As an example, the literature has identified more than 300 style factors for equity alone (Harvey et al., 2014).

In this article, we look at the definition of a strategic factor allocation, and underline the importance of diversification across factors. We then analyze the benefits of dynamic allocation between these factors depending on the economic cycle. A section is devoted to discussing macroeconomic factors, which allow investors to get exposure to or hedging against certain macroeconomic shocks susceptible to impact their assets or liabilities. Finally, we emphasise the difficulties that may arise when implementing factor-based portfolio allocation.

Key points

  • Risk factors are the building blocks that explain asset returns.
  • A number of factors, particularly on equity markets, have a proven capacity to add value.
  • Diversification between different factors is key to limit volatility and maximum drawdown on an international equity portfolio.
  • The performance of a naive diversification strategy across factors can be further improved using dynamic factor weighting based on the current position in the economic cycle.
  • Some factors follow very long cycles and may not work at all for several years.
  • A factor-based approach is particularly helpful for investors whose assets and/or liabilities are sensitive to certain macroeconomic shocks.
  • Investors should nonetheless be aware of certain difficulties with factor implementation, linked to the integration of transaction costs as well as the multiple, and sometimes common exposures in factor indices.
  • The factor-based approach is a source of added value in terms of allocating a portfolio and analysing its risk level.


BRIERE Marie , Amundi Research - Advisory Research
RUSSO, CFA Alessandro , Head of Equity Quant Research at Amundi
TAZE-BERNARD Eric , Chief Allocation Advisor

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Factor Asset Allocation: What are the Benefits for Investors?
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