Summary

Empirical Evidence of Risk Factors

From Risk Factors to Factor Investing
Asset Allocation with Risk Factors

Factor Investing and Equity Portfolio Construction1

Thierry Roncalli?

?
Lyxor Asset Management, France

Amsterdam, January 2015

1 The
materials used in these slides are taken from Cazalet Z. and Roncalli T. (2014),
Facts and Fantasies About Factor Investing, Lyxor Research Paper, 116 pages.
Thierry Roncalli Factor Investing and Equity Portfolio Construction 1 / 114
 Summary
Empirical Evidence of Risk Factors
From Risk Factors to Factor Investing
Asset Allocation with Risk Factors

Lyxor Research Paper

http://ssrn.com/abstract=2524547
Thierry Roncalli Factor Investing and Equity Portfolio Construction 2 / 114
 Summary
Empirical Evidence of Risk Factors
From Risk Factors to Factor Investing
Asset Allocation with Risk Factors

Outline

3 From Risk Factors to Factor

1 Summary Investing
From risk factors to factor Factor indexes
investing Long/short vs long-only
Factor zoo portfolios
Facts and fantasies Capacity

2 Empirical Evidence of Risk 4 Asset Allocation with Risk

Factors Factors
SMB, HML and WML A magical world?
Volatility Optimal allocation
Other risk factors Robustness

Thierry Roncalli Factor Investing and Equity Portfolio Construction 3 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Risk factors versus factor investing

Risk factor
It is a pattern that explains the cross-section of asset returns and that will
explain the cross-section of asset returns in the future.

Risk factors were initially based on systematic and common risks. They
embed now other dimensions, such as anomalies or trading strategies.

Risk factors are one of the pillars of performance measurement (Carhart,

1997).

Thierry Roncalli Factor Investing and Equity Portfolio Construction 4 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Risk factors versus factor investing

Factor investing (marketing message)

Strategic asset allocation based on asset classes is an issue, because:
it is difficult to estimate their risk premia;
correlations between asset classes are time-varying and not stable;
we dont know if it is the right level of aggregation.

Asset classes are exposed to independent risk factors, which are rewarded
on the long-run, meaning that strategic asset allocation based on risk
factors is more easy and robust.

Factor investing consists in:

building factor mimicking portfolios (asset management & index
providers);
allocating between risk factors (investors).

Thierry Roncalli Factor Investing and Equity Portfolio Construction 5 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

What is the rationale for factor investing?

At the security level, there is a lot of idiosyncratic risk or alpha:

Common Idiosyncratic
Risk Risk
GOOGLE 47% 53%
NETFLIX 24% 76%
MASTERCARD 50% 50%
NOKIA 32% 68%
TOTAL 89% 11%
AIRBUS 56% 44%

Thierry Roncalli Factor Investing and Equity Portfolio Construction 6 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

What is the rationale for factor investing?

Idiosyncratic risk decreases with the size of the investment portfolios:

Common Idiosyncratic
Portfolio
Risk Risk
Renaissance Europe 69.2% 30.8%
Threadneedle Pan European SC 87.5% 12.5%
Franklin Mutual European 90.2% 9.8%
SG Actions Euro Value 91.7% 8.3%
Metropole Selection 91.8% 8.2%
Allianz Europe Equity Growth 92.0% 8.0%

Thierry Roncalli Factor Investing and Equity Portfolio Construction 7 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

What is the rationale for factor investing?

2009: Professors Report on the Norwegian GPFG (Ang, Goetzmann

and Schaefer) Risk factors represent 99.1% of the fund return
variation

What lessons can we draw from this?

Idiosyncratic risks and specific bets disappear in (large) diversified
portfolios. Performance of institutional investors is then exposed to risk
factors.

Alpha is not scalable, but risk factors are scalable.

Risk factors are the only bets that are compatible with diversification.

Is that really true?

Thierry Roncalli Factor Investing and Equity Portfolio Construction 8 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

The cross-section of expected returns

Cross-section of expected returns

The objective is to explain the dispersion of asset returns at time t (not
the time-variation).
10 value-weighted (or equally-weighted) sorted portfolios (by deciles)
25 VW/EW sorted portfolios
e.g. independent sorts into 5 size groups and 5 B/M groups
Universe of stocks

Two statistical tools are used:

t-stat (are asset returns sensitive to the factor?)
R 2 (how many variance is explained?)

If XMY (e.g. HML) is a risk factor, -XMY (e.g. LMH) is a risk factor.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 9 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Risk premium versus risk premia

CAPM
There is one risk premium, which can be captured by the market portfolio.

Factor investing
There are other risk premia than the market risk premium. They
correspond to rewarded risk factors.

If XMY (e.g. HML) is a risk premium, -XMY (e.g. LMH) is not a risk
premium.
XMY is a risk premium XMY is a risk factor.
XMY is a risk factor ; XMY is a risk premium.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 10 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Risk factors and anomalies

' $
HML Factor
(Value Strategy)
Q
 Q
 Q
 Q
+
 s
Q
Aggressive Portfolio Defensive Portfolio

? ?
Distressed Risk Quality Stocks
(Fama and French, 1998) (Piotroski, 2000)

? ?
2008 Financial Crisis Dot.com bubble
& %

Thierry Roncalli Factor Investing and Equity Portfolio Construction 11 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Factor zoo

Figure: Harvey et al. (2014)

Now we have a zoo of new factors (Cochrane, 2011).

Thierry Roncalli Factor Investing and Equity Portfolio Construction 12 / 114
 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Factors, factors everywhere

Standard predictive regressions fail to reject the hypothesis that

the party of the U.S. President, the weather in Manhattan,
global warming, El Nio, sunspots, or the conjunctions of the
planets, are significantly related to anomaly performance. These
results are striking, and quite surprising. In fact, some readers
may be inclined to reject some of this papers conclusions solely
on the grounds of plausibility. I urge readers to consider this
option carefully, however, as doing do so entails rejecting the
standard methodology on which the return predictability
literature is built.(Novy-Marx, 2014).

MKT, SMB, HML, WML, STR, LTR, VOL, IVOL, BAB, QMJ, LIQ,
TERM, CARRY, DIV, JAN, CDS, GDP, INF, etc.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 13 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

The alpha puzzle (Cochrane, 2011)

Chaos
E [Ri ] Rf = i
Sharpe (1964)
E [Ri ] Rf = im (E [Rm ] Rf )
Chaos again

E [Ri ] Rf = i + im (E [Rm ] Rf )

Fama and French (1992)

E [Ri ] Rf = im (E [Rm ] Rf ) + ismb E [Rsmb ] + ihml E [Rhml ]

This is not the end of the story...

Thierry Roncalli Factor Investing and Equity Portfolio Construction 14 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

The alpha puzzle (Cochrane, 2011)

Its just the beginning!

Chaos again
E [Ri ] Rf = i + im (E [Rm ] Rf ) + ismb E [Rsmb ] + ihml E [Rhml ]
Carhart (1997)
E [Ri ]Rf = im (E [Rm ] Rf )+ismb E [Rsmb ]+ihml E [Rhml ]+iwml E [Rwml ]
Chaos again
E [Ri ] Rf = i + im (E [Rm ] Rf ) + ismb E [Rsmb ] +
ihml E [Rhml ] + iwml E [Rwml ]
Etc.

How can alpha always come back?

Thierry Roncalli Factor Investing and Equity Portfolio Construction 15 / 114
 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Facts and fantasies

Main fact
Risk factors are a powerful tool to understand the cross-section of
(expected) returns.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 16 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Facts and fantasies

Fact
Common risk factors explain more variance than idiosyncratic risks in
diversified portfolios.

Some risk factors are more relevant than others, for instance SMB,
HML and WML.

Risk premia are time-varying and low-frequency mean-reverting. The

length of a cycle is between 3 and 10 years.

The explanatory power of risk factors other than the market risk
factor has declined over the last few years, because Beta has been
back since 2003.

4
Thierry Roncalli Factor Investing and Equity Portfolio Construction 17 / 114
 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Facts and fantasies

Fact
Long-only and long/short risk factors have not the same behavior.
This is for example the case of BAB and WML factors.

Risk factors are local, not global. It means that risk factors are not
homogeneous. For instance, the value factors in US and Japan cannot
be compared (distressed stocks versus quality stocks).

Factor investing is not a new investment style. It has been largely

used by asset managers and hedge fund managers for a long time.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 18 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Facts and fantasies

Main fantasy
There are many rewarded risk factors.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 19 / 114

 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Facts and fantasies

Fantasy
Risk factors are not dependent on size. It is a fantasy. Some risk
factors present a size bias, like the HML risk factor.

HML is much more rewarded than WML.

WML exhibits a CTA option profile. This is wrong. The option profile
of a CTA is a long straddle whereas WML presents some similarities
to a short call exposure.

Long-only risk factors are more risky than long/short risk factors.
This is not always the case. For instance, the risk of the long/short
WML factor is very high.

8
Thierry Roncalli Factor Investing and Equity Portfolio Construction 20 / 114
 Summary
From risk factors to factor investing
Empirical Evidence of Risk Factors
Factor zoo
From Risk Factors to Factor Investing
Facts and fantasies
Asset Allocation with Risk Factors

Facts and fantasies

Fantasy
HML is riskier than WML. It is generally admitted in finance that
contrarian strategies are riskier than trend-following strategies.
However, this is not always the case, such as with the WML factor,
which is exposed to momentum crashes.

Strategic asset allocation with risk factors is easier than strategic

asset allocation with asset classes. This is not easy, in particular in a
long-only framework. Estimating the alpha, beta and idiosyncratic
volatility of a long-only risk factor remains an issue, implying that
portfolio allocation is not straightforward.

8
Thierry Roncalli Factor Investing and Equity Portfolio Construction 21 / 114
 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Fama-French risk factors

Fama-French three-factor model
We have:

E [Ri ] Rf = im (E [Rm ] Rf ) + ismb E [Rsmb ] + ihml E [Rhml ]

where Rsmb is the return of small stocks minus the return of large stocks,
and Rhml is the return of stocks with high book-to-market values minus
the return of stocks with low book-to-market values.
The factors are defined as follows:
1 1
SMBt = (Rt (SV) + Rt (SN) + Rt (SG)) (Rt (BV) + Rt (BN) + Rt (BG))
3 3
1 1
HMLt = (Rt (SV) + Rt (BV)) (Rt (SG) + Rt (BG))
2 2
with the following 6 portfolios:
Value Neutral Growth
Small SV SN SG
Big BV BN BG
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 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Dynamics of the three risk factors

Figure: Fama-French US risk factors (1930 - 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 23 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Dynamics of the three risk factors

Figure: Fama-French SMB factor (1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 24 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Dynamics of the three risk factors

Figure: Fama-French HML factor (1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 25 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The cross-section of asset returns

Cross-section = 100 value-weighted portfolios (independent sorts into 10
size groups and 10 B/M groups

Figure: R 2 coefficient (in %) US

Thierry Roncalli Factor Investing and Equity Portfolio Construction 26 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The cross-section of asset returns

2 2
Table: Average of RFF RCAPM (in %)
Year Asia Pacific Europe Japan North America US
1995 12.1 13.7 10.0 17.9 18.0
1996 11.7 14.4 9.8 22.5 23.0
1997 12.7 17.6 11.1 22.4 20.2
1998 13.0 19.1 14.0 21.1 18.4
1999 12.8 19.9 15.2 19.2 19.2
2000 13.1 27.2 20.4 29.5 31.6
2001 13.0 26.4 21.1 30.3 36.1
2002 12.3 23.4 20.9 28.6 35.0
2003 13.3 20.3 19.4 27.3 34.4
2004 13.5 17.5 19.3 27.1 33.2
2005 11.5 11.6 13.9 17.7 23.7
2006 11.3 8.8 14.2 13.0 15.7
2007 12.5 7.5 15.4 11.3 13.6
2008 9.6 6.3 15.8 10.0 11.4
2009 6.1 5.0 15.5 7.1 7.8
2010 5.9 5.7 15.0 6.8 7.9
2011 5.4 5.1 14.1 5.9 6.9
2012 4.8 4.9 13.7 5.3 6.3
2013 5.3 5.1 12.1 5.3 6.3
Thierry Roncalli Factor Investing and Equity Portfolio Construction 27 / 114
 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The cross-section of asset returns

Figure: Frequency of the R 2 coefficient with S&P 500 stocks (1995-2013)

Alpha (or idiosyncratic risk) exists!

Thierry Roncalli Factor Investing and Equity Portfolio Construction 28 / 114
 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The size effect in the HML risk factor

SHML is the HML factor for small stocks

BHML is the HML factor for big stocks

1 1
HMLt = (Rt (SV) + Rt (BV)) (Rt (SG) + Rt (BG))
2 2
1 1
= (Rt (SV) Rt (SG)) + (Rt (BV) Rt (BG))
2 2
1 1
= SHMLt + BHMLt
2 2
The HML factor may be biased toward a size factor because of two
effects:
the SHML factor contributes more than the BHML factor;
the BHML factor is itself biased by a size effect.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 29 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The size effect in the HML risk factor

Figure: Fama-French SHML, BHML and HML factors (1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 30 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The size effect in the HML risk factor

Table: Performance of the SHML, BHML and HML factors (1995 2013)
Statistic Factor Asia Pacific Europe Japan North America US
SHML 12.0 7.4 4.2 5.4 5.1
(x ) BHML 1.8 2.6 5.0 0.2 0.6
HML 7.1 5.2 4.8 2.9 2.4
SHML 11.7 10.0 11.0 15.2 13.4
(x ) BHML 15.2 11.0 13.3 11.2 11.9
HML 11.5 9.0 10.3 12.1 11.5
SHML 1.03 0.74 0.38 0.35 0.38
SR (x | r ) BHML 0.12 0.24 0.38 0.02 0.05
HML 0.61 0.57 0.47 0.24 0.20

Thierry Roncalli Factor Investing and Equity Portfolio Construction 31 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The size bias of the BHML factor

Figure: Size ratio between the big value and the big growth portfolios

Thierry Roncalli Factor Investing and Equity Portfolio Construction 32 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Stock-based versus fund-based risk factors

Figure: The Morningstar style box

Value Core Growth

Large

Mid

Small

We can build SMB and HML risk factors by using the performance of
mutual funds.
Thierry Roncalli Factor Investing and Equity Portfolio Construction 33 / 114
 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Stock-based versus fund-based risk factors

Figure: Comparison between FF and MF SMB risk factors (US, 1999-2014))

Thierry Roncalli Factor Investing and Equity Portfolio Construction 34 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Stock-based versus fund-based risk factors

Figure: Comparison between FF and MF HML risk factors (US, 1999-2014))

Thierry Roncalli Factor Investing and Equity Portfolio Construction 35 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Stock-based versus fund-based risk factors

Table: Correlation between FF and MF risk factors (1999 2013)

Factor Europe Japan US

SMB 79.8 86.0 93.9
HML 55.5 54.3 84.8

Thierry Roncalli Factor Investing and Equity Portfolio Construction 36 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Stock-based versus fund-based risk factors

Figure: Comparison between FF and MF HML risk factors (Europe, 1999-2014))

Thierry Roncalli Factor Investing and Equity Portfolio Construction 37 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Momentums?

' $
    
Short-term reversal
Trend-following
  
Long-term reversal
-
k k
1 Day - 1 Month 2 Months - 2 Years 2 Years - 5 Years

Jegadeesh and Titman (1993)

Lehman (1990) De Bondt and Thaler (1985)
& %

Thierry Roncalli Factor Investing and Equity Portfolio Construction 38 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Carhart four-factor model

Carhart four-factor model
We have:

E [Ri ]Rf = im (E [Rm ] Rf )+ismb E [Rsmb ]+ihml E [Rhml ]+iwml E [Rwml ]

where Rwml is the return difference of winner and loser stocks of the past
twelve months.
Fama and French (2012) considered six portfolios:

Loser Average Winner

Small SL SA SW
Big BL BA BW

They then define the WML factor as follows:

1 1
WMLt = (Rt (SW) + Rt (BW)) (Rt (SL) + Rt (BL))
2 2

Thierry Roncalli Factor Investing and Equity Portfolio Construction 39 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Performance of the WML factor

Table: Performance of the WML factor

Statistic Period Asia Pacific Europe Japan North America US
#1 3.8 19.9 8.7 22.6 17.6
(x ) #2 11.9 11.5 0.3 1.4 3.7
#3 5.6 2.9 2.0 4.5 9.3
#1 24.7 12.8 22.1 18.7 14.5
(x ) #2 12.7 15.9 14.1 20.0 20.1
#3 15.2 17.3 14.0 15.3 19.9
#1 0.15 1.56 0.40 1.21 1.22
SR (x | r ) #2 0.93 0.72 0.02 0.07 0.19
#3 0.37 0.17 0.14 0.30 0.47

#1 January 1995 March 2000

#2 April 2000 March 2009
#3 April 2009 December 2013

Thierry Roncalli Factor Investing and Equity Portfolio Construction 40 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Performance of the WML factor

Table: Yearly return of the WML factor (in %)
Year Asia Pacific Europe Japan North America US
1995 2.3 24.9 15.4 13.1 14.6
1996 20.2 19.2 6.5 4.5 5.5
1997 25.9 11.4 53.9 11.6 9.5
1998 30.2 17.4 16.6 24.1 22.2
1999 2.6 30.9 66.8 51.3 29.0
2000 15.9 23.5 30.8 9.7 16.9
2001 27.8 22.2 16.0 8.3 10.4
2002 40.7 53.1 6.2 29.5 28.1
2003 11.8 11.5 15.1 10.7 17.8
2004 18.1 7.7 7.3 2.2 0.3
2005 9.7 17.8 21.3 19.7 15.3
2006 26.3 13.1 3.8 4.0 6.5
2007 13.6 20.2 10.0 22.0 22.8
2008 3.4 27.5 15.3 5.9 18.3
2009 39.5 37.6 33.0 42.0 52.7
2010 4.8 30.3 3.3 6.6 5.7
2011 14.3 9.5 3.5 5.1 8.4
2012 19.6 3.6 2.3 0.9 1.1
2013 38.0 20.7 16.1 12.9 6.2
Thierry Roncalli Factor Investing and Equity Portfolio Construction 41 / 114
 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Momentum crashes (Daniel and Moskowitz, 2013)

Figure: Distribution of WML monthly returns

Thierry Roncalli Factor Investing and Equity Portfolio Construction 42 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The size effect in the WML risk factor

Figure: The SWML, BWML and WML factors (1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 43 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The size effect in the WML risk factor

Table: Performance of the SWML, BWML and WML factors (1995 2013)
Statistic Factor Asia Pacific Europe Japan North America US
SWML 12.7 17.7 0.4 7.4 4.9
(x ) BWML 2.9 5.3 2.4 3.0 2.5
WML 8.0 11.5 1.7 5.3 3.8
SWML 16.2 14.1 15.3 19.0 19.4
(x ) BWML 20.9 18.3 20.4 19.8 19.7
WML 17.3 15.5 16.6 18.7 18.8
SWML 0.78 1.25 0.03 0.39 0.25
SR (x | r ) BWML 0.14 0.29 0.12 0.15 0.13
WML 0.46 0.74 0.10 0.28 0.20

Thierry Roncalli Factor Investing and Equity Portfolio Construction 44 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

The size neutrality of the BWML factor

Figure: Size ratio between the big value and the big growth portfolios

Thierry Roncalli Factor Investing and Equity Portfolio Construction 45 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

WML does not exhibit a CTA option profile

Figure: Payoff of CTA and conditional payoff of WML

Thierry Roncalli Factor Investing and Equity Portfolio Construction 46 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Volatility

Three anomalies
Low volatility anomaly
Idiosyncratic volatility anomaly
Low beta anomaly

They are strongly related.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 47 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Low volatility anomaly

CAPM
Let x1 and x2 be two diversified portfolios. The expected return is an
increasing function of the volatility of the portfolio:

(x2 ) > (x1 ) (x2 ) > (x1 )

Not always verified (Haugen and Baker, 1991; Clarke et al., 2006; Blitz
and van Vliet, 2007).

Minimum variance portfolio, rank-based portfolios.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 48 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Idiosyncratic volatility anomaly

Ang et al. (2006) defined IVOL as the volatility of the idiosyncratic risk
i (t) corresponding to the residual of the Fama-French regression:

Ri (t) = i + im Rm (t) + ismb Rsmb (t) + ihml Rhml (t) + i (t)

By sorting stocks by exposure to IVOL, Ang et al. (2006) observed that

the return difference between the first quintile portfolio and the last
quintile portfolio was 1.06% per month in the United States, and that
these results cannot be attributed to size, value, momentum or liquidity
factors (Ang et al., 2009).

Robustness of the results? Bali and Cakini (2008), Fu (2009).

Thierry Roncalli Factor Investing and Equity Portfolio Construction 49 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Low beta anomaly

Figure: What is the impact of borrowing constraints on the market portfolio?

Thierry Roncalli Factor Investing and Equity Portfolio Construction 50 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Low beta anomaly

Frazzini and Pedersen (2014)

If the investors face some borrowing contraints, the relationship between
the risk premium and the beta of asset i becomes:

E [Ri ] Rf = i + im (E [Rm ] Rf )

where i = (1 im ) is a decreasing function of i .

This can be linked to the empirical evidence of Black et al. (1972), which
found that the slope of the security market line is lower than the
theoretical slope given by the CAPM.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 51 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Low beta anomaly

Example
We consider four assets where 1 = 5%, 2 = 6%, 3 = 8%, 4 = 6%,
1 = 15%, 2 = 20%, 3 = 25% and 4 = 20%. The correlation matrix C
is equal to:
1.00
0.10 1.00
C =
0.20 0.60 1.00
0.40 0.50 0.50 1.00
The risk-free rate is set to 2%.

Table: Tangency portfolio x ? without any constraints

Asset xi? i (x ? ) i (x ? )
1 47.50% 0.74 3.00%
2 19.83% 0.98 4.00%
3 27.37% 1.47 6.00%
4 5.30% 0.98 4.00%
Thierry Roncalli Factor Investing and Equity Portfolio Construction 52 / 114
 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Low beta anomaly

Let us suppose that the market includes two investors. The first investor
cannot leverage his risky portfolio, whereas the second investor must hold
50% of his wealth in cash. We obtain:
Asset xm,i i i (xm ) i (xm ) i + i (xm )
1 42.21% 0.32% 0.62 2.68% 3.00%
2 15.70% 0.07% 0.91 3.93% 4.00%
3 36.31% 0.41% 1.49 6.41% 6.00%
4 5.78% 0.07% 0.91 3.93% 4.00%

Table: Betting-against-beta (BAB) portfolios

Portfolio #1 #2 #3 #4
x1 1 0 1 5
x2 0 1 1 0
x3 1 0 3 5
x4 0 1 1 0
E [R (x )] 0.79% 0.00% 1.51% 3.94%
(R (x )) 26.45% 21.93% 46.59% 132.24%

Thierry Roncalli Factor Investing and Equity Portfolio Construction 53 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Low beta anomaly

Table: Performance of the BAB factor (1995-2013)

Asset class (x ) (x ) SR (x | r )
USD Equities 9.04% 14.96% 0.60
JPY Equities 2.65% 13.12% 0.20
DEM Equities 6.38% 17.98% 0.36
FRF Equities 3.03% 26.26% 0.12
GBP Equities 5.31% 14.41% 0.37
International Equities 7.73% 8.20% 0.94
US Treasury Bonds 1.73% 2.95% 0.59
US Corporate Bonds 5.43% 10.81% 0.50
Currencies 1.12% 8.64% 0.13
Commodities 4.78% 17.76% 0.27
All assets 5.36% 4.34% 1.24

Thierry Roncalli Factor Investing and Equity Portfolio Construction 54 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Links between VOL, IVOL and BAB

CAPM

i2 = (im )2 m
2
+ i2
|{z} | {z } |{z}
VOL BETA IVOL

Figure: Relation between im and IVOLi (Fama-French)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 55 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Links between VOL, IVOL and BAB

Figure: Difference between the low beta and low volatility anomalies

Thierry Roncalli Factor Investing and Equity Portfolio Construction 56 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Liquidity
Pstor and Stambaugh (2003) suggested including a liquidity premium in
the Fama-French-Carhart model:

E [Ri ] Rf = im (E [Rm ] Rf ) + ismb E [Rsmb ] + ihml E [Rhml ] +

wml liq  
i E [Rwml ] + i E Rliq

where LIQ measures the shock or innovation of the aggregate liquidity.

Alphas of decile portfolios sorted

on predicted liquidity betas

Long Q10 / Short Q1:

9.2% wrt 3F
7.5% wrt 4F

Thierry Roncalli Factor Investing and Equity Portfolio Construction 57 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Carry
Let Xt be the capital allocated at time t to finance a futures position on
asset St . Koijen et al. (2013) showed that the expected excess return is
the sum of the carry and the expected price change:

Et [St+1 ]
Et [Rt+1 (X )] Rf = Ct +
Xt
where Ct = (St Ft ) /Xt is the carry.
Currencies:
Ct ' it i
Equities:
Ct ' DYt Rf
Bonds
Roll-down strategy
Carry of the slope: Ct ' Rt10Y Rt2Y

Thierry Roncalli Factor Investing and Equity Portfolio Construction 58 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Carry
Table: Performance of DB currency carry strategies (1995-2013)
Universe (x ) (x ) SR (x | r )
G10 4.31% 10.48% 0.41
Balanced 7.44% 10.87% 0.68
Global 5.02% 11.68% 0.43

Figure: Performance of DB currency carry indices

Thierry Roncalli Factor Investing and Equity Portfolio Construction 59 / 114

 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Quality
Piotroski (2000) argues that the success of the value strategy is explained
by the strong performance of quality stocks, and not by the performance
of distressed stocks.
Scoring system:
1 Piotroski (2000): profitability, leverage/liquidity, operating efficiency.
2 Novy-Marx (2013): gross profitability.
3 Asness et al. (2013): profitability, payout ratio, required return,
growth.

Asness et al. (2013) defined the QMJ factor as follows:

1 1
QMJt = (Rt (SQ) + Rt (BQ)) (Rt (SJ) + Rt (BJ))
2 2
with the following six portfolios:
Junk Median Quality
Small SJ SM SQ
Big BJ BM BQ
Thierry Roncalli Factor Investing and Equity Portfolio Construction 60 / 114
 Summary
SMB, HML and WML
Empirical Evidence of Risk Factors
Volatility
From Risk Factors to Factor Investing
Other risk factors
Asset Allocation with Risk Factors

Quality
Table: Statistics for the SQMJ, BQMJ and QMJ factors (1995 2013)
US Global
Statistic
SQMJ BQMJ QMJ SQMJ BQMJ QMJ
(x ) 5.9 2.7 4.4 7.2 3.0 5.2
(x ) 13.5 10.4 10.8 10.0 8.6 8.5
SR (x | r ) 0.44 0.26 0.41 0.73 0.35 0.60

Figure: Performance of the QMJ, SQMJ and BQMJ factors

Thierry Roncalli Factor Investing and Equity Portfolio Construction 61 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Asset universe: academics versus investors

Academics generally use a large asset universe provided by the Center for
Research in Security Prices (CRSP) or Standard and Poors (Compustat
and Xpressfeed).

Table: Average number of stocks to compute FF HML factor

Asia Pacific Europe Japan North America US

Big 326 615 591 888 846
Small 2646 4093 1840 2982 2385
Total 2972 4708 2431 3870 3231

Remark
NBIM had about 1900 and 1300 American and Japanese stocks in its
portfolio at the end of December 2013.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 62 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Asset universe

Figure: Performance of risk factors with the S&P 500 index (1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 63 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Weighting scheme

Three weighting methods:

1 Value-weighted (VW) portfolios:

MEi if Ri < Q1
wi
+MEi if Ri > Q2

where Q1 and Q2 are two numbers such that Q1 < R < Q2 .

2 Equally-weighted (EW) portfolio:

1 if Ri < Q1
wi
+1 if Ri > Q2

3 Rank-weighted portfolios:
  
Ri R 
 if Ri < Q1
wi
+ Ri R  if Ri > Q2

Thierry Roncalli Factor Investing and Equity Portfolio Construction 64 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Weighting scheme

Figure: Comparison of VW and EW risk factors (US, 1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 65 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Weighting scheme

Figure: Impact of (Q1 , Q2 ) on HML and WML factors (S&P 500, 1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 66 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Factor replication

Factor model
We consider a set of n assets {A1 , . . . , An } and a set of m risk factors
{F1 , . . . , Fm }. We denote by R the (n 1) vector of asset returns at time
t, while is its associated covariance matrix. We also denote by F the
(m 1) vector of factor returns at time t and its associated covariance
matrix. We assume the following linear factor model:

R = + BF +

where is a (n 1) vector, B is a (n m) matrix and is a (n 1)

centered random vector of covariance D.

The beta ij of asset i with respect to factor Fj is (B)i,j .

Thierry Roncalli Factor Investing and Equity Portfolio Construction 67 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Factor replication

Example
We consider n = 6 assets and m = 3 factors. The loadings matrix is:
0.9 0.3 2.5

1.1 0.5 1.5
1.2 0.6 3.4
B=
0.8 0.8 1.2

0.8 0.2 2.1
0.7 0.4 5.2
The three factors are uncorrelated and their volatilities are equal to 20%, 15% and 1%.
We consider a diagonal matrix D with specific volatilities 10%, 13%, 5%, 8%, 18% and
8%.

We have to estimatePthe replication portfolio x in order to define the

replicated factor Fj? = ni=1 xi Ri .

Thierry Roncalli Factor Investing and Equity Portfolio Construction 68 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Factor replication

Table: Minimizing the tracking error volatility

Portfolio #1 #2
Factor 1 2 3 1 2 3
x1 8.4 1.2 0.7 8.5 1.3 1.3
x2 6.3 10.8 1.5 6.4 12.0 2.6 #1 = without
x3 39.9 39.6 2.0 40.5 44.0 3.6 constraints.
x4 23.2 56.3 1.5 23.6 62.5 2.6
x5 3.2 5.7 0.5 3.2 6.4 0.9
x6 19.2 13.3 4.2 19.5 14.8 7.5 #2 = same
1 97.0 1.5 0.1 98.5 1.7 0.1 volatility than
2 2.7 81.0 1.1 2.8 90.0 1.9 the original
3 26.3 246.1 32.4 26.7 273.4 56.9
RC?1 100.0 0.0 0.0 100.0 0.0 0.0
factor.
RC?2 0.0 100.0 0.0 0.0 100.0 0.0
RC?3
0.0 0.0 100.0 0.0 0.0 100.0
Fj? | Fj 3.5 6.5 0.8 3.5 6.7 0.9
?


Fj 19.7 13.5 0.6 20.0 15.0 1.0

Thierry Roncalli Factor Investing and Equity Portfolio Construction 69 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

How to define factor indexes?

Factor replication

Table: Comparison of the three approaches

Approach Sensitivity Beta Risk contribution

Factor 1 2 3 1 2 3 1 2 3
x1 16.7 16.3 2.2 17.4 4.2 2.7 15.2 13.9 2.1
x2 20.4 27.1 1.3 17.9 40.4 3.7 18.6 42.9 2.9
x3 22.3 32.6 2.9 17.7 16.0 1.0 19.3 2.3 2.5
x4 14.9 43.4 1.0 17.8 55.7 0.5 19.6 68.5 0.1
x5 14.9 10.9 1.8 17.4 29.9 3.6 16.0 15.3 2.6
x6 13.0 21.7 4.5 17.7 1.6 3.9 16.4 5.5 5.4
1 97.1 25.0 1.5 97.1 0.0 0.0 97.3 0.7 0.1
2 8.5 83.6 4.0 0.0 81.0 0.0 0.0 82.7 2.4
3 32.7 252.8 45.6 0.0 0.0 42.7 0.4 0.0 51.7
RC? 1 99.6 11.0 9.8 99.8 0.0 0.0 100.0 0.0 0.0
RC? 2 0.3 91.2 25.3 0.0 100.5 0.0 0.0 100.0 0.0
RC? 3
0.1 2.2 64.8 0.0 0.0 89.5 0.0 0.0 100.0
Fj? | Fj 4.8 8.6 1.0 4.8 9.2 1.1 4.7 8.8 1.0
?


Fj 20.0 15.0 1.0 20.0 15.0 1.0 20.0 15.0 1.0

Thierry Roncalli Factor Investing and Equity Portfolio Construction 70 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

From long/short to long-only solutions

Factor replication
Table: Impact of the long-only constraint
Approach Tracking error Sensitivity Beta
Factor 1 2 3 1 2 3 1 2 3
x1 8.5 0.0 0.8 16.7 13.4 1.4 17.4 0.0 0.0
x2 6.4 0.0 0.0 20.4 22.4 0.0 17.9 40.3 0.0
x3 40.5 57.0 2.9 22.3 26.9 2.0 17.7 18.2 1.7
x4 23.6 0.0 0.0 14.9 0.0 0.0 17.8 0.0 0.0
x5 3.2 0.0 0.5 14.9 0.0 1.2 17.4 0.0 2.8
x6 19.5 0.0 0.0 13.0 0.0 0.0 17.7 0.0 0.0
1 98.5 68.3 4.7 97.1 68.9 4.6 97.1 66.2 4.2
2 2.8 34.2 1.9 8.5 31.3 1.4 0.0 31.1 0.4
3 26.7 193.7 13.1 32.7 91.3 12.9 0.0 1.5 11.6
RC? 1 100.0 83.9 89.2 99.6 87.7 90.7 99.8 81.9 78.7
RC? 2 0.0 12.1 7.0 0.3 12.7 2.4 0.0 14.6 1.1
RC? 3
0.0 2.1 4.1 0.1 0.5 6.1 0.0 0.0 8.7
Fj? | Fj 3.5 17.2 1.3 4.8 17.6 1.3 4.8 17.6 1.3
?


Fj 20.0 15.0 1.0 20.0 15.0 1.0 20.0 15.0 1.0

The correlation matrix between replicated portfolios becomes:

 
1.00
C= 0.93 1.00
0.95 0.99 1.00

Thierry Roncalli Factor Investing and Equity Portfolio Construction 71 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

From long/short to long-only solutions

We define the following three risk factors in the case of the

Fama-French-Carhart model:
1
SMB+
t = (Rt (SV) + Rt (SN) + Rt (SG))
3
1
HML+
t = (Rt (SV) + Rt (BV))
2
1
WML+
t = (Rt (SW) + Rt (BW))
2

Thierry Roncalli Factor Investing and Equity Portfolio Construction 72 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

From long/short to long-only solutions

Figure: Performance of long/short and long-only risk factors (US, 1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 73 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

From long/short to long-only solutions

Figure: Performance of long-only risk factors (US, 1995 2013)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 74 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

From long/short to long-only solutions

Table: Correlation matrix of risk factors (US, 1995 2013)

Factor MKT SMB HML WML SMB+ HML+ WML+

Volatility 15.9 12.1 11.5 18.8 20.4 17.7 18.4
MKT 100
SMB 25 100
HML 23 36 100
WML 28 8 15 100
SMB+ 87 66 18 22 100
HML+ 87 33 19 34 90 100
WML+ 89 53 29 7 92 81 100

Thierry Roncalli Factor Investing and Equity Portfolio Construction 75 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

From long/short to long-only solutions

Long/short portfolio x : 100% of market risk and % of long/short
risk factors.
Long-only portfolio x + : (100 ) % of market risk and % of
long-only risk factors.
Table: Statistics (in %) of long/short and long/only portfolios (US, 1995 2013)

Portfolio #0 #1 #2 #3 #4 #5 #6 #7 #8
SMB 0.0 10.0 20.0 0.0 20.0 30.0 0.0 50.0 100.0
HML 0.0 10.0 20.0 20.0 20.0 30.0 0.0 50.0 100.0
WML
0.0 10.0 0.0 20.0 20.0 30.0 60.0 50.0 100.0
x 9.9 11.2 11.1 12.0 12.5 13.7 13.5 16.0 21.0
+


x 11.0 11.2 11.5 12.1 13.2 12.8 13.5 13.5


x+| x 0.2 0.0 0.5 0.4 0.5 0.8 2.5 7.5



x 15.9 15.6 16.2 14.8 15.5 15.9 16.7 17.3 24.5
+


x 16.2 16.5 16.1 16.9 17.7 17.0 18.1 18.1


x+ | x 1.7 1.0 3.5 3.5 5.2 8.6 8.0 18.1
+


x ,x 99.5 99.8 97.8 98.0 95.8 86.9 89.8 67.8

Thierry Roncalli Factor Investing and Equity Portfolio Construction 76 / 114

 Summary
Factor indexes
Empirical Evidence of Risk Factors
Long/short vs long-only portfolios
From Risk Factors to Factor Investing
Capacity
Asset Allocation with Risk Factors

Capacity and liquidity

Lesmond et al. (2004): momentum profits are offset by trading costs.

Korajczyk and Sadka (2004): the break-even fund sizes for long-only
momentum strategies are between $2 and $5 billion (relative to
December 1999 market capitalization).
Frazzini et al. (2012) estimate the following break-even sizes (in $
billion) for long/short risk factors:

Factor SMB HML WML STR

US 103 83 52 9
Global 156 190 89 13

The issue for long-term investors is the absolute value of transaction

costs, not the relative value.
/ alpha = 5%, TC = 1%
, alpha = 3%, TC = 1 bp

Thierry Roncalli Factor Investing and Equity Portfolio Construction 77 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

A magical world

Figure: The arithmetic of Sharpe ratio

In the case of long/short risk factors, we have SR (x ) m SR (F) where
SR (F) is the average Sharpe ratio.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 78 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

A magical world
The cash + long/short 5F portfolio

We consider a 5F long/short portfolio with SMB, HML, WML, BAB

and QMJ risk factors.
The targeted volatility is equal to 10%.

Table: Performance of the 5F and MKT portfolios (1995 2013)

Statistic Asia Pacific Europe Japan North America US

5F MKT 5F MKT 5F MKT 5F MKT 5F MKT
(x ) 13.2 9.2 14.3 9.2 6.8 0.6 11.2 10.2 10.0 9.9
(x ) 10.0 21.6 10.0 18.1 10.0 18.6 10.0 15.9 10.0 15.9
SR (x | r ) 1.04 0.29 1.14 0.35 0.40 0.12 0.83 0.47 0.71 0.45
MDD (x ) 21.6 60.2 19.9 58.9 21.4 58.1 17.7 50.9 21.4 50.4

Thierry Roncalli Factor Investing and Equity Portfolio Construction 79 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

A magical world
The cash + long/short 5F portfolio

MKT 5F
The correlation matrix between MKT The correlation matrix between 5F
portfolios for the 5 regions is: portfolios for the 5 regions is:

1.00 1.00
0.78 1.00 0.48 1.00
C = 0.56 0.51 1.00 C = 0.56 0.38 1.00
0.77 0.84 0.50 1.00 0.43 0.74 0.34 1.00

0.76 0.83 0.49 1.00 1.00 0.43 0.74 0.38 0.98 1.00

Thierry Roncalli Factor Investing and Equity Portfolio Construction 80 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

A magical world
The cash + long/short 5F portfolio

Figure: Eigenvalues of the risk factors

Thierry Roncalli Factor Investing and Equity Portfolio Construction 81 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

A magical world
The cash + long/short 5F portfolio

Performance of equally-weighted 5F and MKT global portfolios

(1995 2013)

Statistic 5F MKT
(x ) 13.8 7.7
(x ) 10.0 16.0
SR (x | r ) 1.10 0.31
MDD (x ) 23.3 53.4

Thierry Roncalli Factor Investing and Equity Portfolio Construction 82 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

A magical world
The MKT + long/short 5F portfolio

Table: Performance of the MKT + long/short 5F portfolio (1995 2013)

Statistic Asia Pacific Europe Japan North America US Global
(x ) 20.9 22.2 5.2 19.9 18.5 20.1
(x ) 21.1 16.8 17.8 14.6 14.0 14.2
SR (x | r ) 0.85 1.16 0.13 1.18 1.12 1.22
MDD (x ) 55.3 53.6 55.9 49.6 46.1 45.5

Table: Performance of the MKT portfolio (1995 2013)

Statistic Asia Pacific Europe Japan North America US Global
(x ) 9.2 9.2 0.6 10.2 9.9 7.7
(x ) 21.6 18.1 18.6 15.9 15.9 16.0
SR (x | r ) 0.29 0.35 0.12 0.47 0.45 0.31
MDD (x ) 60.2 58.9 58.1 50.9 50.4 53.4

Thierry Roncalli Factor Investing and Equity Portfolio Construction 83 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

A magical world
The long/only 5F portfolio

Table: Performance of the long-only 5F portfolio (1995 2013)

Statistic Asia Pacific Europe Japan North America US Global
(x ) 13.4 15.5 3.1 15.8 14.3 11.3
(x ) 21.9 16.9 18.1 15.2 16.3 15.6
SR (x | r ) 0.48 0.75 0.02 0.86 0.71 0.54
MDD (x ) 60.5 58.1 58.1 52.5 55.3 54.5
Bad times are not always uncorrelated!

Table: Performance of the MKT portfolio (1995 2013)

Statistic Asia Pacific Europe Japan North America US Global
(x ) 9.2 9.2 0.6 10.2 9.9 7.7
(x ) 21.6 18.1 18.6 15.9 15.9 16.0
SR (x | r ) 0.29 0.35 0.12 0.47 0.45 0.31
MDD (x ) 60.2 58.9 58.1 50.9 50.4 53.4

Thierry Roncalli Factor Investing and Equity Portfolio Construction 84 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

A magical world
The long/only 5F portfolio

Figure: Performance of long-only 5F and MKT global portfolios

Thierry Roncalli Factor Investing and Equity Portfolio Construction 85 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Optimal allocation
Long/short solution

MVO The optimal solution is:

x ? () 1 (F)
MVO? The risk factors are independent implying that:
(Fj )
xj? 2
(Fj )
ERC If the Sharpe ratio is the same for all risk factors, we obtain the ERC
portfolio:
1
xj?
(Fj )
EW If we assume that expected returns and volatilities are the same for all
the factors, the solution is the EW portfolio:
1
xj? =
m
Thierry Roncalli Factor Investing and Equity Portfolio Construction 86 / 114
 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Optimal allocation
Long/short solution

Table: Performance and weights of long/short 5F global portfolios (1995 2013)

EW ERC MVO? MVO

(x ) 13.8 14.0 14.7 15.3
(x ) 10.0 10.0 10.0 10.0
Statistic
SR (x | r ) 1.10 1.11 1.19 1.24
MDD (x ) 23.3 19.8 19.7 21.9
SMB 20.0 25.1 0.0 0.0
HML 20.0 22.6 31.1 46.3
Weight WML 20.0 12.8 13.7 20.6
BAB 20.0 18.2 31.9 26.6
QMJ 20.0 21.4 23.4 6.5

Thierry Roncalli Factor Investing and Equity Portfolio Construction 87 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Optimal allocation
Long-only solution

Optimal portfolio (maximum Sharpe ratio)

     
max j Fj+ r j ? , 0 +
max j + j (m r ? ) , 0
xj?  2 or xj?  2
j+ j+

where ? is a weighted average of risk premia and r ? = r + ? .

What is an optimal long-only risk factors?

High alpha;
Low beta if m ' 0 but high beta otherwise;
Low idiosyncratic volatility.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 88 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Optimal allocation
Long-only solution

Optimal portfolio (tracking error)

   
Fj+ j m + ?j +
+ (1 j ) r + ?
j
j
xj?  2 or xj?  2
j+ j+

where ?j is the gain or cost on the risk factor Fk+ due to long-only
constraints.

The allocation in the market risk factor is the complementary allocation of

the other risk factors.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 89 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Robustness

Figure: Comparison of Long/short and long-only solutions

Long/short solution

max (RPj , 0)
xj?
VOL2j

Long-only solution (SR) Long-only solution (TE)

max (RPj j ? , 0) RPj j RPm +?j

xj? xj?
IVOL2j IVOL2j

Thierry Roncalli Factor Investing and Equity Portfolio Construction 90 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Robustness
Stability

Example
We consider a universe of three risk factors:
j j+ j j+ j
F1 2% 2% 7% 7% 1.10
F2 3% 3% 10% 10% 0.90
F3 3% 3% 12% 12% 1.00

The other parameters are m = 6%, m = 20% and r = 2%.

This initial parameter set is disturbed as follows:
Set #0 #1 #2 #3 #4 #5 #6
2 / 2+ 4% 0%
3 / 3+ 8%
2 0.70
m 10%
m 2%

Thierry Roncalli Factor Investing and Equity Portfolio Construction 91 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Robustness
Stability

Table: Long/short solution

Set #0 #1 #2 #3 #4 #5 #6
x1? 44.54 40.15 34.68 44.54 44.54 44.54 66.21
x2? 32.73 39.35 25.49 32.73 32.73 32.73 0.00
x3? 22.73 20.50 39.83 22.73 22.73 22.73 33.79
SR (x ? | r ) 0.68 0.78 0.79 0.68 0.68 0.68 0.54

Thierry Roncalli Factor Investing and Equity Portfolio Construction 92 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Robustness
Stability

Table: Long-only solution (SR)

Set #0 #1 #2 #3 #4 #5 #6
x1? 0.00 0.00 0.00 0.00 33.40 0.00 30.50
x2? 64.39 87.44 47.81 72.74 40.16 74.19 0.00
x3? 35.61 12.56 52.19 27.26 26.44 25.81 69.50
SR (x ? | r ) 0.33 0.37 0.34 0.35 0.58 0.15 0.31
(x ? | b) 2.74 3.52 2.81 2.13 2.64 3.00 2.82
(x ? | b) 7.83 9.04 6.42 9.09 5.63 8.18 8.63
IR (x ? | b) 0.35 0.39 0.44 0.23 0.47 0.37 0.33

Thierry Roncalli Factor Investing and Equity Portfolio Construction 93 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Robustness
Stability

Table: Long-only solution (TE, = 1)

Set #0 #1 #2 #3 #4 #5 #6
x1? 21.44 0.00 0.00 42.64 21.08 0.00 42.64
x2? 29.83 82.26 14.29 0.00 30.15 58.06 0.00
x3? 48.73 17.74 85.71 57.36 48.78 41.94 57.36
xb? 0.00 0.00 0.00 0.00 0.00 0.00 0.00
SR (x ? | r ) 0.32 0.37 0.33 0.30 0.56 0.15 0.30
(x ? | b) 2.75 3.49 2.94 2.74 2.75 3.00 2.74
(x ? | b) 6.74 8.65 7.01 7.55 6.75 7.77 7.55
IR (x ? | b) 0.41 0.40 0.42 0.36 0.41 0.39 0.36

Thierry Roncalli Factor Investing and Equity Portfolio Construction 94 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Robustness
Stability

Table: Long-only solution (TE, = 20)

Set #0 #1 #2 #3 #4 #5 #6
x1? 23.65 24.02 23.65 24.63 24.26 20.01 22.64
x2? 13.41 18.23 13.41 8.79 13.11 15.19 0.00
x3? 10.42 10.42 23.44 10.42 10.42 10.42 10.42
xb? 52.52 47.33 39.50 56.16 52.21 54.38 66.94
SR (x ? | r ) 0.26 0.27 0.28 0.25 0.50 0.06 0.24
(x ? | b) 1.23 1.55 1.62 1.06 1.24 1.17 0.86
(x ? | b) 2.48 2.78 2.85 2.30 2.49 2.42 2.07
IR (x ? | b) 0.50 0.56 0.57 0.46 0.50 0.48 0.41

Thierry Roncalli Factor Investing and Equity Portfolio Construction 95 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Robustness
SAA versus TAA

Constant mix strategy = right answer?

Not obvious if risk premia are time-varying and mean-reverting.

BUT

How to diversify bad times (or skewness premia)?

Thierry Roncalli Factor Investing and Equity Portfolio Construction 96 / 114

 Summary
A magical world?
Empirical Evidence of Risk Factors
Optimal allocation
From Risk Factors to Factor Investing
Robustness
Asset Allocation with Risk Factors

Robustness
Scalability

Scalability of risk factors?

Index-based or fund-based management (execution)?

Thierry Roncalli Factor Investing and Equity Portfolio Construction 97 / 114

 Conclusion

Factor investing = a powerful tool, but not so easy to manipulate:

The zoo of factors (Cochrane, 2011)
Factor investment products (indexes, strategies & funds) 6= risk
factors
Allocating between risk factors is not straightforward.

Factor investing = a complementary approach and not a substitute to

traditional asset allocation

Investment universe for managing large portfolios

=
Beta (or asset classes) + Risk Factors (or new betas)

Thierry Roncalli Factor Investing and Equity Portfolio Construction 98 / 114

 Conclusion

Table: Definition of Smart Beta

Risk Factors: Market Risk Factor Other Risk Factors

Traditional Beta Alternative Betas

Beta:
(Old Beta) (New Betas)

CW, EW, SMB, HML, WML,

Smart Beta: MDP, ERC BAB, QMJ
MV?

Thierry Roncalli Factor Investing and Equity Portfolio Construction 99 / 114

 References
Ang A. (2014).
Asset Management A Systematic Approach to Factor Investing.

Asness C.S., Frazzini A. and Pedersen L.H. (2013).

Quality Minus Junk.
SSRN, www.ssrn.com/abstract=2435323.
Carhart M.M. (1997).
On Persistence in Mutual Fund Performance.
Journal of Finance, 52(1), pp. 57-82.

Cochrane J.H. (2011).

Presidential Address: Discount Rates.
Journal of Finance, 66(4), pp. 1047-1108.

Fama E.F. and French K.R. (2012).

Size, Value, and Momentum in International Stock Returns.
Journal of Financial Economics, 105(3), pp. 457-472.

Frazzini A. and Pedersen L.H. (2013).

Betting Against Beta.
Journal of Financial Economics, 111(1), pp. 1-25.
Thierry Roncalli Factor Investing and Equity Portfolio Construction 100 / 114
 References
Harvey C.R., Liu Y. and Zhu H. (2014).
. . . and the Cross-Section of Expected Returns.
SSRN, www.ssrn.com/abstract=2249314

Haugen R.A. and Baker N.L. (1991).

The Efficient Market Inefficiency of Capitalization-Weighted Stock Portfolios.
Journal of Portfolio Management, 17(3), pp. 35-40.

Ilmanen A. (2011).
Expected Returns: An Investors Guide to Harvesting Market Rewards.

Jegadeesh N. and Titman S. (1993).

Returns to Buying Winners and Selling Losers: Implications for Stock Market
Efficiency.
Journal of Finance, 48(1), pp. 65-91.

Pastor L. and Stambaugh R.F. (2001).

Liquidity Risk and Expected Stock Returns.
Journal of Political Economy, 111(3), pp. 642-685.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 101 / 114
 Tables

For Year 2014, all computations are done on the full year except:
() : January-November 2014;
() : January-October 2014.

The source of data are the following:

Kenneth French library for MKT, SMB, HML and WML;
AQR library for BAB and QMJ.

Thierry Roncalli Factor Investing and Equity Portfolio Construction 102 / 114
 Tables
Yearly return of the MKT factor (in %)

Year Asia Pacific Europe Japan North America US

1995 14.9 19.3 2.5 35.7 36.8
1996 22.9 21.9 16.1 22.3 21.1
1997 20.6 19.9 28.7 30.8 31.2
1998 6.7 25.5 7.5 22.9 24.3
1999 46.6 19.7 81.7 23.3 25.2
2000 15.6 9.9 32.9 7.8 11.6
2001 8.1 20.0 28.9 10.7 11.4
2002 7.0 14.0 7.8 21.3 21.1
2003 50.5 42.7 41.0 32.5 31.8
2004 28.6 23.6 17.3 13.1 11.9
2005 13.4 11.9 27.2 7.9 6.1
2006 33.8 37.0 1.0 15.6 15.4
2007 36.5 14.1 4.9 7.8 5.7
2008 51.1 45.7 26.0 37.9 36.7
2009 77.4 35.5 5.2 31.9 28.3
2010 22.4 6.1 16.2 18.3 17.5
2011 15.2 13.0 10.3 0.7 0.5
2012 24.6 21.1 6.5 15.6 16.4
2013 6.2 28.5 26.7 32.3 35.2
2014 1.6 6.5 2.6 10.7 11.7
Thierry Roncalli Factor Investing and Equity Portfolio Construction 103 / 114
 Tables
Yearly return of the SMB factor (in %)

Year Asia Pacific Europe Japan North America US

1995 10.3 8.3 3.5 3.1 5.7
1996 4.0 1.9 8.6 3.1 2.0
1997 9.3 12.3 33.1 8.8 4.8
1998 15.8 13.6 8.9 19.6 19.3
1999 12.9 11.7 8.9 9.8 13.4
2000 20.1 7.0 1.1 3.1 4.8
2001 3.6 0.7 5.1 16.3 20.4
2002 1.4 6.5 2.1 0.6 3.9
2003 13.5 8.8 14.3 17.6 22.2
2004 6.2 7.5 17.0 5.7 5.0
2005 9.6 5.0 10.7 0.0 1.8
2006 7.1 6.1 20.4 0.6 0.5
2007 0.3 8.0 7.3 5.8 7.8
2008 22.4 10.2 6.3 0.7 7.0
2009 20.4 8.6 0.3 9.6 7.9
2010 9.4 9.7 4.5 15.7 12.9
2011 10.6 8.7 9.3 6.1 5.0
2012 9.1 1.0 1.3 0.6 0.5
2013 1.0 6.2 3.1 2.0 6.0
2014 4.1 2.0 6.8 7.4 7.0
Thierry Roncalli Factor Investing and Equity Portfolio Construction 104 / 114
 Tables
Yearly return of the HML factor (in %)

Year Asia Pacific Europe Japan North America US

1995 1.0 5.0 3.5 2.0 0.8
1996 7.1 1.6 9.0 5.2 1.4
1997 2.4 12.2 12.8 11.4 9.6
1998 11.3 0.6 1.7 13.6 10.2
1999 11.5 17.0 32.5 25.3 26.7
2000 23.7 33.0 60.1 48.9 37.3
2001 18.0 33.0 20.2 11.7 14.8
2002 18.3 26.9 14.4 18.2 12.6
2003 13.7 15.6 9.2 4.6 3.2
2004 8.3 9.2 8.6 9.0 8.7
2005 1.5 8.0 0.3 7.0 8.6
2006 2.1 7.9 14.5 11.6 12.7
2007 4.5 0.6 5.9 12.4 11.6
2008 9.0 3.1 21.3 0.2 2.0
2009 5.1 1.7 3.8 1.7 1.8
2010 1.1 5.3 0.3 1.1 2.1
2011 1.9 14.1 5.5 4.5 6.8
2012 14.9 1.4 1.6 5.6 6.8
2013 5.0 7.9 2.3 0.7 0.4
2014 9.2 6.1 0.3 5.6 3.5
Thierry Roncalli Factor Investing and Equity Portfolio Construction 105 / 114
 Tables
Yearly return of the SHML factor (in %)

Year Asia Pacific Europe Japan North America US

1995 2.9 3.1 0.7 3.6 2.4
1996 3.3 2.4 3.9 8.6 10.6
1997 11.0 14.3 1.6 19.4 22.7
1998 8.1 4.2 3.5 7.2 3.1
1999 16.5 22.8 39.0 28.6 29.8
2000 30.4 33.4 49.3 57.5 40.0
2001 29.6 50.1 21.3 14.1 15.6
2002 34.6 45.2 19.4 31.3 29.4
2003 23.2 13.1 6.5 0.9 6.1
2004 12.1 10.3 2.6 6.5 5.8
2005 10.4 11.0 1.7 5.2 9.7
2006 0.2 4.4 19.5 11.8 12.2
2007 22.7 6.6 11.7 9.6 15.5
2008 19.4 8.3 20.9 16.9 11.4
2009 6.8 2.9 3.7 0.1 1.0
2010 7.8 4.4 4.7 0.7 0.1
2011 1.9 10.3 9.6 0.5 3.4
2012 18.8 1.4 1.6 4.5 5.5
2013 15.8 7.3 1.3 0.9 2.5
2014 4.2 1.4 1.9 5.9 3.9
Thierry Roncalli Factor Investing and Equity Portfolio Construction 106 / 114
 Tables
Yearly return of the BHML factor (in %)

Year Asia Pacific Europe Japan North America US

1995 1.2 6.9 6.3 0.5 0.8
1996 18.1 0.8 14.2 1.7 7.2
1997 14.7 10.1 23.4 3.6 2.7
1998 13.5 3.4 6.8 19.9 17.0
1999 6.5 11.0 27.0 22.3 23.9
2000 14.7 31.7 70.9 38.9 34.0
2001 6.9 16.7 18.5 8.6 13.6
2002 3.6 9.7 9.2 5.5 3.1
2003 4.6 18.0 26.2 8.3 0.3
2004 4.2 8.0 14.3 11.4 11.8
2005 7.0 5.0 2.6 8.6 7.5
2006 3.8 11.4 9.7 11.3 13.0
2007 11.7 7.5 0.1 15.1 7.5
2008 1.2 13.6 21.4 14.6 7.0
2009 3.8 5.8 4.2 3.5 5.0
2010 5.7 6.5 5.3 1.5 4.4
2011 5.8 17.9 1.5 9.3 10.2
2012 10.9 4.0 1.8 6.6 8.0
2013 5.1 8.4 5.9 2.3 3.2
2014 14.4 10.6 2.6 5.4 3.2
Thierry Roncalli Factor Investing and Equity Portfolio Construction 107 / 114
 Tables
Yearly return of the WML factor (in %)

Year Asia Pacific Europe Japan North America US

1995 2.3 24.9 15.4 13.1 14.6
1996 20.2 19.2 6.5 4.5 5.5
1997 25.9 11.4 53.9 11.6 9.5
1998 30.2 17.4 16.6 24.1 22.2
1999 2.6 30.9 66.8 51.3 29.0
2000 15.9 23.5 30.8 9.7 16.9
2001 27.8 22.2 16.0 8.3 10.4
2002 40.7 53.1 6.2 29.5 28.1
2003 11.8 11.5 15.1 10.7 17.8
2004 18.1 7.7 7.3 2.2 0.3
2005 9.7 17.8 21.3 19.7 15.3
2006 26.3 13.1 3.8 4.0 6.5
2007 13.6 20.2 10.0 22.0 22.8
2008 3.4 27.5 15.3 5.9 18.3
2009 39.5 37.6 33.0 42.0 52.7
2010 4.8 30.3 3.3 6.6 5.7
2011 14.3 9.5 3.5 5.1 8.4
2012 19.6 3.6 2.3 0.9 1.1
2013 38.0 20.7 16.1 12.9 6.2
2014 11.2 4.9 3.6 1.2 1.4
Thierry Roncalli Factor Investing and Equity Portfolio Construction 108 / 114
 Tables
Yearly return of the SWML factor (in %)

Year Asia Pacific Europe Japan North America US

1995 14.7 30.0 19.5 23.8 25.8
1996 19.1 31.2 14.6 10.3 6.3
1997 25.7 12.2 29.0 16.5 15.1
1998 19.7 28.2 17.1 24.6 25.0
1999 4.6 52.5 45.2 56.2 32.0
2000 15.2 16.6 21.8 10.3 43.6
2001 41.1 26.7 13.3 14.1 17.2
2002 43.8 64.6 1.5 34.8 36.9
2003 14.7 11.3 15.3 10.8 16.7
2004 24.3 12.1 12.0 3.3 0.3
2005 11.6 27.2 19.8 19.0 15.6
2006 35.6 15.9 3.8 1.8 3.9
2007 24.1 21.8 14.1 21.9 18.0
2008 12.4 32.0 14.3 2.9 7.9
2009 42.2 34.7 34.5 49.1 60.8
2010 11.0 36.4 1.5 5.5 1.9
2011 17.8 17.8 0.9 11.9 16.5
2012 32.3 9.8 1.4 4.0 3.4
2013 41.3 25.6 18.9 15.9 5.8
2014 25.0 15.1 2.5 3.3 1.2
Thierry Roncalli Factor Investing and Equity Portfolio Construction 109 / 114
 Tables
Yearly return of the BWML factor (in %)

Year Asia Pacific Europe Japan North America US

1995 9.1 19.7 11.3 3.2 4.2
1996 20.9 8.2 2.2 1.2 4.5
1997 25.4 10.3 81.7 6.6 3.9
1998 41.2 6.8 16.8 23.4 18.9
1999 9.3 11.0 88.5 45.7 25.3
2000 17.3 30.3 39.4 27.2 5.8
2001 15.1 17.0 17.8 2.5 3.4
2002 37.0 42.0 13.6 23.9 19.2
2003 8.8 11.9 15.3 10.7 18.9
2004 12.0 3.5 2.7 1.0 0.3
2005 7.7 9.0 22.5 20.1 14.8
2006 17.4 10.3 4.1 6.3 9.1
2007 3.5 18.6 5.7 21.9 27.7
2008 5.3 22.8 15.7 8.6 29.3
2009 36.8 40.5 31.7 34.1 43.2
2010 1.4 24.3 7.9 7.6 9.5
2011 10.6 1.5 8.0 1.3 0.7
2012 7.8 2.5 2.9 2.1 5.6
2013 34.0 15.9 13.3 9.8 6.4
2014 1.5 4.5 4.8 0.7 1.6
Thierry Roncalli Factor Investing and Equity Portfolio Construction 110 / 114
 Tables
Yearly return of the BAB factor (in %)

Year Asia Pacific() Europe() Japan() North America() US()

1995 10.6 9.6 10.8 22.6 23.7
1996 0.1 13.4 4.8 31.1 31.8
1997 9.8 5.1 15.6 45.8 47.1
1998 11.0 9.9 8.5 13.0 13.2
1999 29.9 9.8 30.7 34.2 35.3
2000 5.4 23.4 13.4 14.0 14.3
2001 6.8 17.9 4.5 12.6 12.3
2002 12.7 52.6 7.4 37.0 35.4
2003 6.7 21.4 1.6 16.2 10.4
2004 22.7 46.3 21.6 31.8 30.3
2005 14.6 4.1 13.5 14.8 12.9
2006 7.4 28.2 3.9 12.6 11.0
2007 30.9 14.8 2.9 4.2 6.8
2008 0.1 20.7 23.2 33.9 35.0
2009 21.9 6.3 10.6 16.2 9.9
2010 22.1 4.4 3.1 8.4 6.4
2011 11.1 17.8 22.9 5.6 4.1
2012 7.8 3.6 0.6 16.7 16.0
2013 12.0 16.8 7.5 20.6 20.3
2014 19.8 8.3 15.3 13.0 12.2
Thierry Roncalli Factor Investing and Equity Portfolio Construction 111 / 114
 Tables
Yearly return of the QMJ factor (in %)

Year Asia Pacific() Europe() Japan() North America() US()

1995 2.5 7.6 2.9 3.6 3.3
1996 6.0 3.4 8.4 8.7 9.0
1997 22.7 5.3 22.3 8.5 8.0
1998 1.1 6.6 1.1 13.4 13.5
1999 2.4 8.5 4.5 7.1 7.8
2000 13.1 6.7 6.9 24.4 24.0
2001 15.7 14.9 16.9 17.0 16.1
2002 11.3 17.0 7.4 23.4 22.6
2003 19.8 12.5 26.2 17.9 18.2
2004 5.3 4.3 8.1 0.7 0.0
2005 9.5 3.0 16.9 1.1 0.4
2006 17.1 2.4 28.0 5.1 4.8
2007 8.0 11.6 13.5 8.0 6.9
2008 25.8 31.4 15.6 38.7 38.1
2009 5.9 5.7 2.7 14.7 14.4
2010 2.5 2.6 1.2 7.7 7.6
2011 16.0 24.7 14.6 22.4 21.8
2012 3.2 0.5 9.0 3.7 5.8
2013 2.6 2.7 10.4 0.1 2.0
2014 7.4 9.2 11.2 4.5 3.1
Thierry Roncalli Factor Investing and Equity Portfolio Construction 112 / 114
 Tables
Yearly return of the SQMJ and BQMJ factors (in %) US

Year SQMJ() BQMJ() QMJ()

1995 0.5 6.0 3.3
1996 10.0 7.9 9.0
1997 16.0 0.3 8.0
1998 11.2 15.6 13.5
1999 8.6 7.4 7.8
2000 40.4 8.0 24.0
2001 14.9 16.3 16.1
2002 36.6 9.5 22.7
2003 22.4 13.9 18.2
2004 6.1 5.9 0.0
2005 3.7 4.4 0.4
2006 3.3 6.4 4.8
2007 5.7 8.1 6.9
2008 37.4 38.5 38.1
2009 19.7 9.1 14.4
2010 6.6 8.6 7.6
2011 22.0 21.4 21.8
2012 5.7 6.1 5.8
2013 0.0 3.9 1.9
2014 2.0 4.1 3.1
Thierry Roncalli Factor Investing and Equity Portfolio Construction 113 / 114
 Tables
Yearly return of the SQMJ and BQMJ factors (in %) Global

Year SQMJ() BQMJ() QMJ()

1995 0.4 5.5 2.9
1996 7.1 5.9 6.6
1997 11.0 3.3 7.1
1998 9.1 10.4 9.8
1999 6.7 5.1 5.8
2000 28.7 8.3 18.5
2001 20.0 12.5 16.4
2002 33.5 8.4 20.4
2003 19.1 13.9 16.5
2004 6.3 4.3 0.9
2005 1.4 5.4 2.0
2006 1.8 2.4 0.3
2007 9.4 8.9 9.2
2008 33.0 34.8 34.0
2009 11.5 8.3 9.8
2010 0.2 4.8 2.5
2011 22.8 20.7 21.8
2012 2.1 4.5 1.2
2013 5.0 2.5 1.2
2014 7.1 6.0 6.5
Thierry Roncalli Factor Investing and Equity Portfolio Construction 114 / 114