Factor investing: alpha concentration versus diversification

Lars Heinrich (), Antoniya Shivarova () and Martin Zurek ()
Additional contact information
Lars Heinrich: W&W Asset Management GmbH
Antoniya Shivarova: European University Viadrina
Martin Zurek: European University Viadrina

Journal of Asset Management, 2021, vol. 22, issue 6, No 6, 464-487

Abstract: Abstract Despite extensive research support, the role of diversification in current factor investing strategies remains neglected. This paper investigates whether well-designed multifactor portfolios should not only be based on firm characteristics, but should also include portfolio diversification effects. While the alpha concentration approach mainly considers factor-specific firm characteristics, the diversified approach utilizes covariance estimators in addition to firm characteristics to account for portfolio diversification. The corresponding out-of-sample results show that including an efficient covariance estimator improves the performance of long-only multifactor portfolios compared to the pure alpha concentration approach. A particular advantage of diversified factor investing strategies can be identified in the significant increase in exposure to the low-volatility factor represented by firm characteristics with high informational content. No significant performance differences are observed for long-short portfolios where the factor exposures of the alpha concentration and diversification approaches are similar with respect to the low-volatility factor.

Keywords: Factor investing; Alpha forecasting; Diversification; Optimal orthogonal portfolio; Information coefficient; Covariance (search for similar items in EconPapers)
JEL-codes: G11 G12 G15 G17 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1057/s41260-021-00226-0 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pal:assmgt:v:22:y:2021:i:6:d:10.1057_s41260-021-00226-0

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/41260

DOI: 10.1057/s41260-021-00226-0

Access Statistics for this article

Journal of Asset Management is currently edited by Marielle de Jong and Dan diBartolomeo

More articles in Journal of Asset Management from Palgrave Macmillan
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().