Abstract
Factor-based allocation embraces the idea of factors, as opposed to asset classes, as the ultimate building blocks of an investment portfolio. Our study contributes to the literature by addressing the question whether there is a superior way of combining factors in a portfolio. We provide a comprehensive comparison of factor-based allocation strategies within a multiple testing framework. Factor-based allocation is profitable, even when applying the necessary multiple testing corrections. Investment portfolios can be efficiently diversified using factor-based allocation since we find robust economic performance over various market states. Ultimately, we provide guidance for investors on the best method to choose when constructing factor-based portfolios. A naive equal-weighted factor portfolio, albeit simple and costless, cannot be outperformed by more sophisticated allocation strategies.
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