Abstract
Given the tremendous growth of factor allocation strategies in active and passive fund management, we investigate whether factor or sector asset allocation strategies provide investors with a superior performance. Our focus is on comparing factor versus sector allocations as some recent empirical evidence indicates the dominance of sector over country portfolios. We analyze the performance and performance differences of sector and factor portfolios for various weighting and portfolio optimization approaches, including “equal-weighting” (1/N), “risk parity,” minimum-variance, mean-variance, Bayes–Stein and Black–Litterman. We employ a sample-based approach in which the sample moments are the input parameters for the allocation model. For the period from May 2007 to November 2020, our results clearly reveal that, over longer investment horizons, factor portfolios provide relative superior performances. For shorter periods, however, we observe time-varying and alternating performance dominances as the relative advantage of one over the other strategy depends on the economic cycle. One important insight is that during “normal” times factor portfolios clearly dominate sector portfolios, whereas during crisis periods sector portfolios are superior offering better diversification opportunities.
Highlights
For many decades, favored asset allocation strategies focused on country or sector portfolios
We compare the performance of two different low-cost asset allocation strategies, one building on investable factors and the other one on investable sectors, both via exchange-traded funds (ETFs)
While Briere and Szafarz (2021) build on Fama–French factors that are not directly investable, we focus on investable factor and sector indices and in addition analyze a variety of different out-of-sample investment strategies
Summary
For many decades, favored asset allocation strategies focused on country or sector portfolios. More recently factor investing emerged as a popular new approach. The idea of factor investing is to diversify a portfolio among the underlying characteristic risk factors, introduced in the literature for explaining stock returns. The main objective of this research is to investigate whether factor-based portfolios perform superiorly relative to sector-based portfolios. We are interested in the question whether factor timing adds value and examine whether dynamic factor. Germany investment strategies outperform a static multifactor benchmark. We extent the earlier research of Briere and Szafarz (2021) by focusing on investable factor and sector indices and by analyzing a variety of different out-of-sample investment strategies
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