Factor Investing Revisited

David Blitz *

Forthcoming Journal of Index Investing

Abstract
This paper takes another look at the recommendation of Blitz [2012] to allocate
strategically to the value, momentum and low-volatility factor premiums in the equity
market. Five years of fresh data shows that such a factor investing strategy continued to
deliver out-of-sample. The potential added value of the two new factors in the FamaFrench 5-factor model, operating profitability and investment, is investigated and found
to depend critically on the performance metric that is considered most important. The
paper also reviews the role of small-cap stocks, factor timing, long-only versus long-short
portfolio construction, international evidence and factor investing beyond equities.

Keywords: factor investing, smart beta, value, momentum, low volatility

JEL Classification: G11, G12, G14

* David Blitz, Ph.D. is the Head of Quantitative Equity Research at Robeco Asset Management and can be
contacted at [email protected] and +31 (0)10 - 224 2079. The views expressed in this paper are solely
those of the author and not necessarily shared by Robeco or its subsidiaries.

Electronic copy available at: http://ssrn.com/abstract=2626336

The literature on asset pricing and mutual fund performance distinguishes between three
different sources of return: (i) exposure to the market risk premium, (ii) exposure to
known factor premiums, such as the value premium, and (iii) alpha, or managerial skill.
Because active investing is a zero-sum game before costs and the evidence for alpha is
weak, investors increasingly choose to focus on passively replicating the capitalizationweighted market index at minimal costs. Although the market risk premium may be
harvested efficiently in this way, it does mean missing out on factor premiums, for which
the evidence is also strong.
Blitz [2012] argues that investors should allocate strategically not only to the risk
premiums offered by traditional asset classes, but also to factor premiums. More
specifically, the study identifies value, momentum, and low-volatility as the three key
factor premiums in the equity market, and argues for a sizable and well-diversified
allocation to these three factors, based on data spanning the 1963-2009 period.
This paper takes another look at such a factor-investing approach. Five years of
out-of-sample data show that the proposed factor mix continued to deliver over the 20102014 period. The potential added value of the two new factors proposed by Fama and
French [2015] to augment their [1993] 3-factor model, operating profitability and
investment, is examined and found to depend critically on whether ones objective is to
maximize absolute or market-relative performance. Finally, the role of small-cap stocks,
factor timing, long-only versus long-short portfolio construction, international evidence
and factor investing beyond equities are discussed.

DATA
Data is obtained primarily from the online data library of professor Kenneth French. The
market portfolio represents the value-weighted return of the entire CRSP universe at each
point in time. The value, momentum, operating profitability and investment stock
portfolios are each top 30% portfolios based on the stocks in the CRSP universe with an
above NYSE-median market capitalization, i.e. big caps. By ignoring the small-cap
segment of the market, where factor premiums are actually known to be bigger (see, e.g.,
Fama and French [2012]), we aim to ensure that the strategies can be implemented on a
large scale, and that the impact of transaction costs that would be incurred in a real-life
2

Electronic copy available at: http://ssrn.com/abstract=2626336

application is limited. The value strategy selects stocks on their book-to-market ratio,
momentum considers past 12-1 month return, operating profitability is defined as annual
revenues minus cost of goods sold, interest expense, and selling, general, and
administrative expenses divided by book equity, and investment takes the change in total
assets (here low is actually better). The low-volatility strategy is not provided by Kenneth
French and therefore self-constructed, following a similar methodology. Specifically, it
selects the 30% stocks with the lowest past 36-month total-volatility in the CRSP
universe of stocks with a market capitalization above the NYSE median. The factor
strategies are considered on an equally-weighted basis as well as on a value-weighted
basis. All returns are taken in excess of the risk-free return provided by Kenneth French.
The sample covers the period from July 1963 until December 2014.

RESULTS
This section discusses the main empirical results, looking first at performance over time,
and next at whether the two new Fama-French factors might add value.

Performance over time

Blitz [2012] considers equity factor investing strategies over the period from July 1963
until December 2009. An extension of these results with five years of fresh, out-ofsample data is given in Exhibit 1. All of the previous conclusions still hold. The first
three columns show that value, momentum and low-volatility individually each exhibit
strong results. Value and momentum are particularly attractive from a return perspective,
although they do involve a somewhat higher volatility than the market portfolio. Lowvolatility, on the other hand, adds less to return, but is particularly attractive from a
volatility perspective. On a risk-adjusted basis, i.e. in terms of Sharpe ratio, the three
factor strategies appear about equally attractive. The column labeled 3x1/3 contains
results for a portfolio which every month simply invests one third each in the value,
momentum and low-volatility strategies. This multi-factor portfolio shows a higher
Sharpe ratio than each of the three underlying strategies. Results for equally-weighted
factor portfolios, shown in Panel A, are stronger than results for value-weighted factor
portfolios, shown in Panel B.
3

INSERT EXHIBIT 1 ABOUT HERE

Exhibit 2 shows performance statistics over the most recent 5-year period, from
January 2010 until December 2014. Over this out-of-sample period the market itself
already showed a very high excess return of 15.6% per annum, arguably reducing the
need for a more sophisticated approach. Still, the (equally-weighted) 3x1/3 portfolio was
able to boost return by an additional 1.9%, and improve the Sharpe ratio from 1.16 to
1.27. Looking at the performance of the individual factors we see that low-volatility was
particularly strong, with a Sharpe ratio of 1.76 and a CAPM alpha of 6.9%. This was
sufficient to offset the relatively weak performance of value and momentum, which did
manage to generate a higher raw return than the market portfolio, but not a superior riskadjusted return (lower Sharpe ratio and negative CAPM alpha). The 3x1/3 portfolio based
on value-weighted factor strategies also shows a higher Sharpe ratio and a positive
CAPM alpha, but the improvement is only about half that of the equally-weighted factor
strategies. Once more, low-volatility saves the day.

INSERT EXHIBIT 2 ABOUT HERE

Although the diversified factor investing strategy continued to deliver in the most
recent 5-year period, one might be concerned that the added value is below the long-term
historical average of Exhibit 1. In order to provide a better feeling for the short- and
medium-term performance of the 3x1/3 strategy, Exhibit 3 plots its 1-, 3- and 5-year
rolling market-relative return. Based on these graphs it is clear that the recent
performance of the 3x1/3 strategy is well within the historically observed range of
outcomes. It also shows that even periods of underperformance are not unusual. Exhibit 4
shows the full-sample estimated probabilities of underperformance over 1-, 3- and 5-year
periods for the 3x1/3 strategy. For the equally-weighted factor investing strategy, the
probability of underperformance is 28% on a 1-year basis, 13% on a 3-year basis and 7%
on a 5-year basis. So even though the strategy added considerable value over the 50+ year

sample period, short-term periods of underperformance did occur, and even on a 5-year
basis the strategy sometimes lagged the market.

INSERT EXHIBIT 3 ABOUT HERE

INSERT EXHIBIT 4 ABOUT HERE

Passive investing ignores factor premiums

Exhibit 5 depicts the full-sample risk-return characteristics of the market, the three factor
strategies, and also the counterparts of these three factor strategies, i.e. the portfolios
consisting of the 30% least attractive stocks on value, momentum and low-volatility.
Panel A shows results for equally-weighted factor portfolios, and Panel B for valueweighted factor portfolios. The graphs not only illustrate again that exposure to value,
momentum and low-volatility has been rewarded with superior market-relative
performance, but also that portfolios with the opposite factor exposures would have
delivered similar-sized underperformances. This is not really surprising, because the
performance of portfolios sorted on any given factor should add up to the market return
again.

INSERT EXHIBIT 5 ABOUT HERE

The graphs in Exhibit 5 also provide a different perspective on passive investing,

i.e. on passively replicating the market portfolio. As the market portfolio contains stocks
with attractive factor characteristics as well as stocks with unattractive factor
characteristics, passive investors effectively buy all the portfolios shown in the graphs.
Blitz [2014] argues that this only makes sense if one believes that the differences in
performance observed historically have no relevance at all for the future, or cannot be
profitably exploited in real-life. Although it is conceivable that factor premiums
disappear going forward, this scenario does not appear to be highly probable in light of
the overwhelming evidence for factor premiums. Even if one does consider this to be the
most likely scenario, it still does not justify putting zero weight on the alternative

possibility that factor return characteristics observed in the past will persist in the future
after all.

The new Fama-French factors

Fama and French [2015] propose to augment their classic [1993] 3-factor model with two
new factors: operating profitability and investment. Exhibit 1 also contains the standalone results for these two new factors, and results for an extension of the 3x1/3 strategy
with these two new factors. Specifically, it shows results for a 5x1/5 portfolio, which
every month invests one fifth each in the value, momentum, low-volatility, operating
profitability and investment factor strategies. If the two new factors are stronger than the
existing ones they are likely to boost performance, but also if their performance is merely
comparable in magnitude, the 5x1/5 portfolio might already improve upon the 3x1/3
portfolio because of improved diversification.
Exhibit 1 shows that, on a stand-alone basis, the two new factors offer a premium
compared to the market portfolio, as both their raw and risk-adjusted returns are higher.
Thus, it makes sense to consider these factors for inclusion in a multi-factor portfolio.
However, the operating profitability factor shows weaker results than value, momentum
and low-volatility (lower Sharpe ratio, lower CAPM alpha), while the investment factor
also appears to be less powerful, especially in the equally-weighted context. This explains
why the 5x1/5 portfolio shows weaker raw and risk-adjusted returns, in particular for the
equally-weighted strategies, but also for the value-weighted strategies. From an absolute
return perspective, therefore, it seems that the two new factors are not really helpful for
improving upon the value, momentum and low-volatility factor mix suggested by Blitz
[2012].
Some words of caution are in place here. First, the two new Fama-French factors
may not add a lot of value, but they also do not seem to destroy a lot of value, as the
negative impact on performance is modest. Using different assumptions, e.g. forwardlooking expected returns instead of historical returns, one or both of the new factors
might well earn a place in a diversified factor mix. Second, the results could also change
for other definitions of the new factors. For instance, Novy-Marx [2013] proposes a
profitability factor that is different from the one chosen by Fama and French [2015].
6

Another example is Asness, Frazzini and Pedersen [2014], who propose a quality factor
that is a composite of over twenty individual variables in four main categories
(profitability, growth, safety and payout). This latter paper does raise the question what
constitutes a factor, and whether it is fair to compare factors based on a single variable
with a factor consisting of a diversified set of variables. For instance, the value,
momentum and low-volatility factors might also be improved by using various different
variables instead of just one. Also, the distinction between different factors can become
blurred. For instance, the safety variables in the quality definition of Asness, Frazzini and
Pedersen [2014] might also be categorized as low-volatility factors, while key elements
of other quality variables could also be incorporated in more sophisticated value factors.

Alternative optimization criteria

Although the 3x1/3 portfolio might be considered quite simplistic, it turns out to be
highly effective from a Sharpe-ratio perspective. Explicitly optimizing for a maximum
Sharpe ratio over the full sample results in Sharpe-ratio improvements of just 0.002
(equally-weighted factor portfolios) and 0.01 (value-weighted factor portfolios) compared
to the 3x1/3 portfolio. Clearly, these improvements are economically negligible and
statistically insignificant. In other words, the simple 3x1/3 factor portfolio is so close to
the maximum Sharpe-ratio portfolio as to be indistinguishable from it.
In theory investors should only care about maximizing their Sharpe ratio, but that
is not always how they behave in practice. For instance, some investors may be interested
in minimizing the volatility of their equity portfolio. In this case a simple 100% allocation
to the low-volatility factor strategy turns out to be optimal, in the equally-weighted as
well as the value-weighted context. Yet another objective might be to maximize the
information ratio, i.e. the market-relative return-to-risk ratio. This often happens in a
decentralized investment process, where first an allocation is made to asset classes based
on absolute risk-return considerations, and next for each asset class delegated portfolio
managers are selected based on their market-relative performance. Exhibit 6 shows the
results of optimizing the multi-factor portfolios for maximum information ratio over the
full sample.

INSERT EXHIBIT 6 ABOUT HERE

In this case the two new Fama-French factors suddenly become a lot more
interesting, receiving combined weights of no less than 30.2% and 53.5% (for equallyweighted and value-weighted factor portfolios respectively), mainly at the expense of the
weight given to the value and low-volatility factors. Compared to the 3x1/3 portfolio this
improves the information ratios by amounts that cannot be dismissed as negligible, from
0.75 to 0.90 and from 0.46 to 0.73 respectively. These improvements are primarily driven
by a reduction of tracking error. Thus, the two new Fama-French factors appear to be
much more attractive from an information-ratio perspective than from a Sharpe-ratio
perspective.
The finding that a low-volatility strategy is less attractive from an informationratio perspective is not surprising, because benchmark-driven investing has been
identified as one of the reasons this anomaly exists in the first place; see, for instance,
Blitz and van Vliet [2007] and Baker, Bradley and Wurgler [2011]. The finding that little
weight is given to value in the portfolios optimized for information ratio may relate to the
observation of Fama and Fench [2015] that value seems to have become redundant in
their 5-factor model. However, Asness, Frazzini, Israel and Moskowitz [2015] show that
a modified value factor, based on book-to-market ratios that assume a publication lag for
book values but not for market values, is not subsumed by other factors.

EXTENSIONS
This section discusses various extensions of the basic value, momentum and lowvolatility factor mix for U.S. equities discussed in the previous section.

Small-cap
Next to the value, momentum and low-volatility factor strategies Blitz [2012] also
considers small-cap stocks as a potential fourth factor strategy. Although the return
premium offered by the small-cap strategy is found to be positive, it is markedly lower
than the premium for the value, momentum and low-volatility strategies. As a result,
small-cap does not make it to the optimal factor mix.
8

Kalesnik and Beck [2014] argue that the evidence supporting the existence of a
size premium is quite weak. They acknowledge that long-term US data suggests a size
premium of 3.4%, but then point out that a much smaller premium, of only about 1%, is
found using global data since the effect was first documented in the early eighties.
Moreover, they argue that (i) there is an upward bias in size premium estimates due to
inaccurate returns on delisted stocks in major databases, (ii) indices and hypothetical
portfolios ignore trading costs, (iii) the statistical significance of the size premium
estimates is likely overstated due to data-mining and reporting bias, (iv) the statistical
significance is very weak, and (v) there is no outperformance on a risk-adjusted basis.
The authors emphasize that their results do not imply that investors should stop investing
in small stocks; only that investors should not expect that small stocks as a group deliver
superior returns.
Fama and French [2012] observe that the value and momentum premiums appear
to be stronger in the small-cap segment of the market. This suggests that a tilt towards
smaller stocks might be necessary in order to unlock the full potential of these factor
premiums. De Groot and Huij [2011] find that the small-cap premium appears to be
concentrated in low-risk small stocks, which implies that the small-cap effect should be
considered in conjunction with the low-volatility effect. Asness, Frazzini, Israel,
Moskowitz and Pedersen [2015] find that a strong size premium emerges after controlling
for their quality-minus-junk factor. Altogether, these studies imply that although smallcap stocks in general are not particularly attractive, it may be attractive to benefit from
the opportunities offered by small-cap stocks for value, momentum, low-volatility and
quality factor strategies. In the previous section equally-weighted factor strategies were
found to deliver better results than value-weighted factor strategies, which is consistent
with the notion that a bottom-up induced towards smaller stocks may be desirable. In this
way, small-caps do not contribute to performance as a stand-alone factor, but as a sort of
catalyst for getting the most out of other factors.

Factor timing
Potentially, the performance of a diversified factor mix, such as the 3x1/3 strategy
discussed in the previous section, could be improved significantly by tactically varying
9

the weights of the individual factor strategies. But whereas there are numerous papers
supporting the existence of value, momentum and low-volatility factor premiums, the
literature is largely silent on how the exposure to these factor strategies might be timed
effectively. In the absence of compelling evidence that it is possible to successfully time
factor weights, the prudent approach is to establish a portfolio that is well-diversified
across different factor strategies. One of the benefits of diversification is that performance
deviations compared to the market portfolio become less extreme. This is illustrated by
the tracking errors reported in Exhibit 1, which are significantly lower for the naively
diversified 3x1/3 portfolios compared to the value, momentum and low-volatility
strategies individually.

Long-only versus long-short

The factor investing strategies discussed in this paper are long only. As such, they
provide exposure to the market risk premium, and, on top of that the premium earned by
stocks with attractive factor characteristics. Others, such as Bender, Briand, Nielsen and
Stefek [2010] and Ilmanen and Kizer [2012], have argued for allocating to long-short
factor strategies. This allows investors to capitalize not only on the (positive) premium
earned by stocks with attractive factor characteristics, but also on the (negative) premium
earned by stocks with unattractive factor characteristics. Long-short strategies miss out
on the market risk premium though. The main attraction of long-short factor strategies is
therefore not their expected return, but their nice property of generating returns that are
virtually uncorrelated with traditional asset classes, making them attractive building
blocks for asset allocation.
However, Huij, Lansdorp, Blitz and van Vliet [2014] argue for caution, because
although a long-short approach does indeed show superior performance in theory, a longonly approach is found to be the preferred alternative after accounting for practical issues
such as benchmark restrictions, implementation costs and factor decay. Benchmark
restrictions refer to the fact that long-short strategies exhibit a very high tracking error
versus the market portfolio. Although this issue can be addressed by adding back market
exposure (bringing the beta from zero back to one again), this goes at the expense of the
low correlation which made long-short strategies so attractive to begin with. Moreover,
10

taking into account moderate estimates for costs and factor decay can already result in the
value added of a long-short implementation disappearing completely.
Another practical consideration is that investors often still have room to scale up
their long-only factor portfolios, for instance by reducing their passive equity allocation.
Intuitively, it is not efficient to buy every stock as part of a passive strategy, and
simultaneously run a long-short strategy which shorts many of the very same stocks
against significant costs. From this perspective a long-short approach only makes sense
for investors who have already converted their entire equity portfolio to long-only factor
strategies, but seek yet more factor exposure.

International evidence
The results presented in Blitz [2012] and this paper are entirely based on U.S. equity
market data. However, value, momentum and low-volatility have also been shown to be
strongly present in international equity markets. Fama and French [1998] provide
evidence for value in Europe and Japan, Rouwenhorst [1998] provides evidence for
momentum in Europe, and Fama and French [2012] reconfirm the effectiveness of value
and momentum in global developed equity markets. Evidence for value and momentum
in emerging markets is provided by Van der Hart, Slagter and van Dijk [2003]. The lowvolatility effect is documented by Blitz and van Vliet [2007] for the U.S., Europe and
Japan, and by Blitz, Pang and van Vliet [2013] for emerging markets. The only exception
seems to be the absence of a clear momentum effect in Japan, although Asness [2011]
argues that after adjusting for the strong negative interaction between momentum and
value strategies, a strong momentum effect is, in fact, also present in Japan. Altogether
these results imply that the value, momentum and low-volatility factor premiums are
quite robust and that factor investing can be applied to the entire global equity portfolio.

Other asset classes

The value, momentum and low-volatility premiums do not appear to be limited to the
equity market, but have also been documented to exist within other asset classes; see, for
instance, Asness, Moskowitz and Pedersen [2013] for value and momentum, and
Falkenstein [2009] for low-volatility. This suggests that factor investing may be applied
11

at a larger scale than just within the context of the equity portfolio. Houweling and van
Zundert [2014] explicitly make the case for factor investing in the corporate bond market,
showing that a diversified factor strategy delivers superior long-term returns. They also
show that the return captured by factors in the corporate bond market is not the same
return that is already captured by the equivalent factors in the equity market. Blitz and de
Groot [2014] consider factor investing for commodity futures, finding that a combination
of commodity value, momentum and low-volatility factors is able to improve upon a
traditional portfolio, but also upon a portfolio that already targets the corresponding
factors in the equity market. Clearly, therefore, factor investing should not be limited to
the equity portfolio, but is something to be investigated at the overall portfolio level.

DOES FACTOR INVESTING REALLY WORK?

Studies that make the case for factor investing, including this one, typically consider
hypothetical (paper) return series. Therefore, one may wonder to which extent these
returns are actually attainable in practice, after accounting for transaction costs,
management fees and other real-life implementation issues. Huij and van Gelderen
[2014] is a recent study which attempts to answer this question, by looking at the longterm performance of mutual funds which provide a significant exposure to established
factor premiums. The authors find strong evidence that mutual funds are able to capitalize
on factor premiums. For instance, the probability of outperforming the market index over
the long run is found to be no less than 66% for funds which, either explicitly or
implicitly, seek to benefit from the value premium. The corresponding probability for
funds without positive exposure to one or more established factors is only 20%.
However, this does not mean that harvesting factor premiums is a straightforward
matter. One observation in this regard is that there is a large dispersion in the returns of
funds that seek to capture a given factor. For instance, even though Huij and van
Gelderen [2014] find that value-exposed funds beat the market on average, a third of the
value-exposed funds underperform the market, and 5% of the value-exposed funds even
do so by more than 5% per annum. Another observation in the same study is that only
very few funds seem to specifically target the momentum factor, and that although the
success rate of these funds seems to be better than average, it remains well below 50%.
12

More evidence that harvesting factor premiums is not a trivial matter is provided
by Hsu (2014), who compares two types of indices designed to benefit from the value
premium. Over the 30-year period ending December 31, 2013 the classic S&P 500 Value
index is found to have underperformed the S&P 500 index by 0.18% per annum, while a
fundamentally-weighted index would have outperformed the S&P 500 index by over 2%
per annum. The study concludes that the various approaches to index construction and
maintenance have markedly different degrees of effectiveness in harvesting factor
premiums. Also on other efficiency criteria, such as transaction costs, investability and
underlying economic exposure, the differences can vary appreciably.

SUMMARY
This paper takes another look at the recommendation of Blitz [2012] to allocate
strategically to the value, momentum and low-volatility factor premiums in the equity
market. Five years of fresh data shows that such a factor investing strategy continued to
deliver out-of-sample. Although performance is lower than over the full sample, it is well
within the historically observed range of outcomes. The two new factors in the FamaFrench 5-factor model, operating profitability and investment, do not appear to be helpful
for further improving absolute performance, but offer more potential for investors
interested in benchmark-relative performance. Small-cap stocks seem to be more
attractive as a catalyst for unlocking the full potential of value, momentum and lowvolatility, than as a basis for a fourth factor next to these three.
The literature provides little support for the possibility to successfully time the
exposure to different factors, which argues in favor of establishing a well-diversified mix
of lowly correlated factors. Although a long-short approach to factor investing may
appear to be superior in theory, practical considerations such as costs, benchmarking and
existing allocations make a long-only approach more appropriate for most investors. As
factor premiums have also been documented for international equity markets, factor
investing can be applied to the global equity portfolio. In fact, it may even be applied to
the entire portfolio, because factor premiums appear to transcend beyond the equity
market, to asset classes such as corporate bonds and commodity futures.

13

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15

EXHIBIT 1 | Full-sample results, 1963:07-2014:12

This exhibit shows performance characteristics of various U.S. equity portfolios. The market portfolio
(column 1) is the Mkt-Rf factor of Kenneth French, which represents the value-weighted return in excess of
the risk-free return of the entire CRSP universe at each point in time. It is also used to calculate CAPM
betas. The value, momentum, operating profitability and investment factor portfolios are each top 30%
portfolios based on the stocks in the CRSP universe with an above NYSE-median market capitalization.
The value strategy selects stocks on their book-to-market ratio, momentum considers past 12-1 month
return, operating profitability is defined as annual revenues minus cost of goods sold, interest expense, and
selling, general, and administrative expenses divided by book equity, and investment takes the change in
total assets (here low is actually better). The low-volatility strategy is not provided by Kenneth French and
therefore self-constructed, following a similar methodology. Specifically, it selects the 30% stocks with the
lowest past 36-month total-volatility in the CRSP universe of stocks with a market capitalization above the
NYSE median. The column labeled 3x1/3 contains results for a portfolio which every month invests one
third each in the value, momentum and low-volatility factor strategies, and the column labeled 5x1/5
contains results for a portfolio which every month invests one fifth each in the value, momentum, lowvolatility, operating profitability and investment factor strategies. All portfolios are constructed without
look-ahead bias, i.e., based on information that was actually available at each point in time, and without
survivorship bias. The factor portfolios are considered on an equally-weighted basis (Panel A) as well as on
a value-weighted basis (Panel B). All returns are taken in excess of the risk-free return provided by
Kenneth French. All performance statistics are annualized, with geometric averaging used for calculating
mean returns. The sample covers the period from July 1963 until December 2014.
Market

Value

Mom.

LowVol.

Profit.

Invest.

3x1/3

5x1/5

Panel A: Equally-weighted factor portfolios

return
volatility
Sharpe ratio

5.0%
15.4%
0.32

9.1%
17.3%
0.53

9.7%
18.4%
0.53

6.7%
12.5%
0.53

7.3%
17.6%
0.41

8.3%
17.4%
0.48

8.7%
15.1%
0.58

8.4%
15.8%
0.53

CAPM beta
CAPM alpha

1.00
0.0%

0.98
4.3%

1.09
4.2%

0.70
3.2%

1.09
1.8%

1.05
3.0%

0.92
4.1%

0.98
3.5%

4.2%
8.4%
0.49

4.7%
7.4%
0.63

1.7%
7.8%
0.22

2.3%
5.2%
0.44

3.3%
6.2%
0.53

3.7%
5.0%
0.75

3.4%
4.4%
0.76

outperformance
tracking error
information ratio

Panel B: Value-weighted factor portfolios

return
volatility
Sharpe ratio

5.0%
15.4%
0.32

7.2%
16.1%
0.45

8.1%
16.9%
0.48

5.2%
12.5%
0.42

5.9%
15.2%
0.39

6.9%
15.1%
0.46

7.0%
14.2%
0.49

6.8%
14.3%
0.48

CAPM beta
CAPM alpha

1.00
0.0%

0.91
2.6%

1.00
3.0%

0.74
1.5%

0.95
1.2%

0.92
2.4%

0.88
2.6%

0.91
2.3%

2.2%
8.0%
0.27

3.1%
6.6%
0.46

0.2%
6.6%
0.03

0.9%
3.7%
0.26

2.0%
5.3%
0.37

2.0%
4.3%
0.46

1.8%
3.4%
0.53

outperformance
tracking error
information ratio

16

EXHIBIT 2 | Out-of-sample results, 2010:01-2014:12

This exhibit is similar to Exhibit 1, except for showing results over the most recent 5 years of the sample
period, from January 2010 until December 2014.
Market

Value

Mom.

LowVol.

Profit.

Invest.

3x1/3

5x1/5

Panel A: Equally-weighted factor portfolios

return
volatility
Sharpe ratio

15.6%
13.5%
1.16

16.7%
15.5%
1.08

17.7%
16.9%
1.04

17.9%
10.1%
1.76

17.9%
15.3%
1.17

19.5%
16.4%
1.19

17.5%
13.8%
1.27

18.0%
14.5%
1.24

CAPM beta
CAPM alpha

1.00
0.0%

1.09
-0.4%

1.18
-0.8%

0.70
6.9%

1.11
0.6%

1.19
0.9%

0.99
2.0%

1.06
1.5%

1.1%
4.7%
0.23

2.0%
6.0%
0.34

2.2%
5.4%
0.41

2.2%
3.4%
0.64

3.9%
3.9%
0.98

1.9%
2.9%
0.64

2.4%
2.6%
0.93

outperformance
tracking error
information ratio

Panel B: Value-weighted factor portfolios

return
volatility
Sharpe ratio

15.6%
13.5%
1.16

14.3%
15.2%
0.94

16.7%
15.4%
1.08

15.6%
10.1%
1.54

15.9%
12.8%
1.24

16.2%
13.5%
1.21

15.6%
12.9%
1.21

15.8%
12.9%
1.23

CAPM beta
CAPM alpha

1.00
0.0%

1.06
-2.2%

1.08
-0.2%

0.69
4.7%

0.92
1.4%

0.96
1.2%

0.94
0.9%

0.94
1.1%

-1.3%
5.2%
-0.26

1.0%
5.0%
0.21

-0.1%
5.6%
-0.02

0.2%
2.8%
0.08

0.6%
3.6%
0.17

0.0%
2.3%
-0.01

0.2%
2.0%
0.09

outperformance
tracking error
information ratio

17

EXHIBIT 3 | Rolling performance 3x1/3 factor strategy

This exhibit shows market-relative returns of the 3x1/3 factor strategy as in Exhibit 1. Panel A shows 1year rolling relative returns, Panel B shows 3-year rolling relative returns and Panel C shows 5-year rolling
relative returns, both for the equally-weighted and the value-weighted 3x1/3 strategy as defined in Exhibit
1.
Panel A: 1-year rolling returns
40%
30%
20%
10%
0%
-10%
-20%
Jul-05

Jul-08

Jul-11

Jul-14

Jul-05

Jul-08

Jul-11

Jul-14

Jul-02

Jul-99

Jul-96

Jul-93

Jul-90

Jul-87

Jul-84

Jul-81

Jul-78

Jul-75

Jul-72

Jul-69

Jul-66

Jul-63

Equally-weighted

Value-weighted

Panel B: 3-year rolling returns

20%
15%
10%
5%
0%
-5%
-10%
Jul-02

Jul-99

Jul-96

Jul-93

Jul-90

Jul-87

Jul-84

Jul-81

Jul-78

Jul-75

Jul-72

Jul-69

Jul-66

Jul-63

Equally-weighted

Value-weighted

18

Panel C: 5-year rolling returns

20%

15%

10%

5%

0%

-5%

-10%

Jul-14
Jul-11
Jul-08
Jul-05
Jul-02
Jul-99

19

Jul-96
Jul-93
Jul-90
Jul-87
Jul-84
Jul-81
Jul-78
Jul-75
Jul-72
Jul-69
Jul-66
Jul-63

Value-weighted
Equally-weighted

EXHIBIT 4 | Underperformance probabilities 3x1/3 factor strategy

This exhibit shows the probability of underperformance of the 3x1/3 factor strategy relative to the market
on a rolling 1-, 3- and 5-year basis, both for the equally-weighted and value-weighted 3x1/3 strategy as
defined in Exhibit 1.
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1Y

3Y
Equally-weighted

5Y

Value-weighted

20

EXHIBIT 5 | Risk-return plots, 1963:07-2014:12

This exhibit depicts the full-sample risk-return characteristics of the market, the value, momentum and lowvolatility factor strategies as in Exhibit 1, and also the counterparts of these three factor strategies, i.e. the
portfolios consisting of the 30% least attractive stocks on value, momentum and low-volatility. Growth is
the opposite of value, MomLos (mnomentum losers) is the opposite of momentum (MomWin, i.e.
momentum winners), and HighVol (high volatility) is the opposite of low volatility (LowVol). Panel A
shows results for equally-weighted factor portfolios, and Panel B for value-weighted factor portfolios.
Panel A: Equally-weighted factor portfolios
12%

Excess return

10%

MomWin
Value

8%
LowVol

6%

Growth

HighVol

Market

4%
2%

MomLos

0%
0%

5%

10%

15%
Volatility

20%

25%

30%

Panel B: Value-weighted factor portfolios

9%
MomWin

8%

Value

Excess return

7%
6%

LowVol
Market
Growth

5%
4%

HighVol

3%
2%

MomLos

1%
0%
0%

5%

10%

15%
Volatility

21

20%

25%

30%

EXHIBIT 6 | Factor allocations optimized for information ratio, 1963:07-2014:12

This exhibit shows results for multi-factor portfolios optimized full sample for maximum information ratio,
and compares results to the 3x1/3 portfolio. It uses the same underlying data and shows the same
performance characteristic as in Exhibit 1.
Factor portfolios
Objective

Equally weighted
3x1/3
IR

Value weighted
3x1/3
IR

Value
Momentum
Low volatility
Profitability
Investment

33.3%
33.3%
33.3%
-

8.7%
45.8%
15.4%
3.0%
27.2%

33.3%
33.3%
33.3%
-

13.8%
32.7%
27.8%
25.7%

return
volatility
Sharpe

8.7%
15.1%
0.58

8.9%
16.2%
0.55

7.0%
14.2%
0.49

7.2%
15.1%
0.48

CAPM beta
CAPM alpha

0.92
4.1%

1.01
3.8%

0.88
2.6%

0.96
2.4%

outperformance
tracking error
information ratio

3.7%
5.0%
0.75

3.9%
4.3%
0.90

2.0%
4.3%
0.46

2.2%
3.0%
0.73

22