Mixed Vs. Integrated Multifactor ETF Portfolios

October 21, 2016

Pros of Mixed Approach

  • Simple-to-understand approach to portfolio construction
  • Each sleeve can seek to independently maximize its target factor exposure
  • Turnover in factor portfolio sleeves can be independently managed

Cons of Mixed Approach

  • Securities in each sleeve are selected to target only a single-factor exposure and may unintentionally introduce negative exposures to other factors

ETFs Using a Mixed Approach

The Integrated/Composite Approach

The integrated (or composite) approach to building a multifactor portfolio relies on selecting stocks that have high exposures to all the target factors simultaneously.

Let’s assume we are trying to build a multifactor portfolio that targets the same factor exposures as our prior example. In the integrated case, we would try to identify the stocks that simultaneously have high exposure to value, size, momentum and low-volatility factors. 

Again, using the language of a style-box-driven approach, a mixed-approach portfolio seeking both “small cap” and “value” exposure would hold the stocks in the small-value bucket:

 

  Value Blend Blend
Large      
Mid      
Small x    

 

Integrated approach managers argue that this approach allows for the most highly concentrated exposure without introducing dilutive effects. Mixed managers would argue that this approach risks missing value premium or size premium generated on the large-value or small-growth edges of the spectrum.

 

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