Multi-Factor Portfolios: A New Factor? Limits of the Static Approach

Abstract

We assess the value added of a multifactor portfolio from a performance-agnostic point of view. First we introduce a broad general definition of factor, that encompasses usual factors like Size or Value, and then we prove that static long–short multifactor strategies (as the equal weighting of factors) are indeed factors according to our definition. This result is new in the literature and states that, by investing in a long–short static multifactor strategy, one is indeed investing into a new (synthetic) factor. Finally we test the strength of such a synthetic factor compared to each single factor by looking at its predictive power. We empirically test the equal-weighting of Value, Size, Momentum and Low Volatility in the US and Europe. Our conclusion is very clear in both regions: the equal-weighting of these four standard factors is a synthetic factor that has no predictive power on stocks’ return, while each of the factors shows clear ability to distinguish among stocks. In other words, the measure that underlies this equal-weighting of factors has zero predictive power on cross-sectional differences in stocks’ returns.