Practical Applications of Choosing Factors: Not “Which?” but “When?”

Abstract

Institutional investors have new tools to inform their construction of factor-based portfolios. Rather than focusing on the choice of factor, says author Michael Hunstad, investors should base their allocations on their investment horizon. By clearly mapping factors—size, value, momentum, low volatility and dividend yield—to their cyclical return patterns, investors can formulate their optimal factor allocation model. Instead of asking ‘Which factor?’ investors should ask ‘When and for how long should I invest?’” explains the author, who is Senior Vice President and Director of Quantitative Research at Northern Trust Asset Management. “When I get the question ‘What’s the best factor?’ I say there isn’t a ‘best’ per se. Every factor can have a place in a portfolio based on your holding period,” he says.