How to use multi-factor strategies
in portfolio construction

Jul 28, 2017
By Andrew Ang, Phd, Holly Framsted, Katie Herzog

Multifactor investing has grown rapidly over the past few years, from $3.8b in assets under management at the end of 2009 to nearly $53b currently. There are now 182 ETFs from 24 fund providers . These funds represent more than 30 distinct strategies, each of which constructs the portfolio differently. With such a multitude of options, it can sometimes be challenging for investors to compare these offerings.

A well-diversified portfolio is something that nearly every fund provider and asset owner strives to build. Multifactor strategies build upon the long-standing concept of diversification: that combining exposures to multiple drivers of differentiated returns — otherwise known as factors — can help mitigate capital market drawdowns and increase the predictability of outperformance.

As anyone who has ever completed a puzzle understands, it is not simply about having the right pieces; it’s also about combining the pieces in the right way to achieve the desired outcome. There are two main methods for constructing multifactor portfolios — top-down factor allocations and bottom-up stock selection — to illuminate how seemingly simple differences can meaningfully impact portfolio exposures and, ultimately, performance.

Top-down vs. bottom-up portfolio construction

Combining distinct sleeves of securities targeting different factors doesn’t necessarily result in a portfolio that is simultaneously strongly tilted towards all factors; rather, the resulting factor exposures are often much closer to neutral.

  1. Top-down approach feels intuitive because you tend to own the strongest stocks in each factor, what it can fail to consider is how those factors come together in a portfolio.
  2. Bottom-up portfolio construction raises the bar for stocks included in the multifactor portfolio by requiring positive exposure to multiple desired attributes.

Conclusion: A bottom-up approach to factor integration may help provide stronger exposures and stronger performance than a top-down combination of factor indexes.

Learn more about these two approaches

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Andrew Ang
Head of Factor Investing Strategies
Andrew Ang, PhD, Managing Director, is Head of Factor Investing Strategies and leads BlackRock’s Factor-Based Strategies Group. Throughout his career, Dr. Ang h
Smart Beta Senior Strategist, BlackRock
SmartBeta Strategist, BlackRock