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White Papers

The Merits and Methods of Multi-Factor Investing

With a wealth of smart beta indices to choose from, market participants may find it difficult to decide when each factor-based strategy is best suited to deliver returns. Historical performances for each factor have been cyclical and have experienced long drawdowns relative to the market. As an alternative to choosing between equity factors, multi-factor portfolios can be constructed to diversify factor risk. Market participants considering multi-factor investing should explore the differences between a top-down, index of indices approach and a bottom-up, stock-level multi-factor approach. Since exposure to desired secondary factors could be weak in each single-factor index, a multi-factor index of indices may experience some factor exposure dilution. In contrast, a stock-level multi-factor index construction approach may help maximize overall factor exposures. Ultimately, multi-factor indices may help market participants avoid the potential pitfalls of timing factors without necessarily missing the upside that the best factor choice may have provided.

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