Risk-Factor Diversification and Portfolio Selection

  • Pappas S
  • Bianchi R
  • Drew M
 et al. 
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Traditionally, investment portfolios have been constructed with a focus on what asset classes to invest in and how much to invest in each. Recent research, however, has shown that focusing on risk-factor allocations, rather than asset class allocations, can result in better risk-adjusted portfolio performance. The existing literature has focused on simple allocation strategies such as equal-weighted and equal-risk-weighted portfolios. In addition to these simple allocation techniques, this paper compares the performance using mean-variance analysis, and presents evidence that the outperformance of risk-factor diversification may not be as conclusive as has been previously presented in the literature. While confirming some of the prior findings on risk-factor diversification, the research shows that previous findings may be subject to strong caveats. Specifically, the evidence suggests that the selection of risk-factors, portfolio selection techniques and time-period have a large impact on performance outcomes.

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  • Scott N. Pappas

  • Robert J. Bianchi

  • Michael E. Drew

  • Rakesh Gupta

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