The Characteristics of Factor Investing

We dissect the realized performance of factor-based equity portfolios using a characteristics-based multi-factor return model. We show that generic single-factor portfolios, which invest in stocks with high scores on one particular factor, are sub-optimal because they ignore the possibility that these stocks may be unattractive from the perspective of other factors. We also show that differences in performance between (i) integrated and mixed-sleeve multi-factor portfolios, (ii) small-cap and large-cap factor portfolios, and (iii) equal and value-weighted factor portfolios can be fully attributed to the differences in their factor characteristics. We conclude that efficient factor investing requires an understanding of how factor characteristics drive portfolio returns