Asset Allocation vs Factor Allocation – Can We Build a Unified Method?

There is increasing interest in the idea of allocating across factors instead of traditional asset classes. Allocating across factors has the intuitive appeal of allocating across building blocks that are in theory purer sources of return. In practice, factor-based allocation is not easy, since factors are unobservable and must be specified. However, we believe there is merit in integrating insights from factors with traditional asset allocation. Information and views about factors and about asset classes can be a powerful combination. In this article, the authors present a framework for combining the two paradigms in an innovative way, resulting in optimal allocations that blend insights from both paradigms. Specifically, their approach derives asset class return prediction from factor-based asset allocation, which allows constructing portfolios for various investment objectives from a unified framework