What difference do new factor models make in portfolio allocation?

Abstract

This paper compares the Hou-Xue-Zhang four-factor model with the Fama-French five-factor model from an investing perspective both in- and out-of-sample. Without margin requirements and model uncertainty, the Hou-Xue-Zhang model outperforms the Fama-French model. However, the outperformance could become negligible if an investor is subject to margin requirements and model uncertainty. The Hou-Xue-Zhang model shows similar power as the Fama-French model in describing the covariance matrix of asset returns. Overall, the two models do not make a difference for investing in a realistic setting.