Pure Quintile Portfolios

In this paper we propose a new portfolio construction framework called Pure Quintile Portfolios. These portfolios overcome the main drawback of naïve quintile portfolios based on single sorts, namely, not having pure exposures to the target factor. Each pure quintile portfolio has the same exposure to the target factor as its naïve counterpart, but also has zero exposures to all other factors. Therefore pure quintile portfolios more accurately reflect the cross sectional distribution of true factor returns. In addition, when we long Q1 and short Q5 to capture factor premia as is most commonly done in research and practice, we find that pure Q1-Q5 portfolio has lower risk and higher Sharpe ratio than naïve Q1-Q5 portfolio for a group of widely used factors, thus providing evidence that our new framework creates more efficient and stable factor premia than naïve quintile portfolios