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Blending Factors in Your Smart Beta Portfolio Are two factors better than one?
BY Vinit Srivastava

In recent years, smart beta strategies have seen a significant increase in popularity. These strategies seek to measure systematic factors and aim to harvest the associated long-term risk premium. While many empirical studies show that smart beta strategies have historically outperformed their cap-weighted benchmarks, there is less evidence to suggest that any one factor will consistently outperform another. In fact, different factors tend to outperform in different market environments. Therefore, holding a combination of these strategies in a blended portfolio could potentially provide a powerful source of diversification and more stable excess return outcomes.

This paper briefly reviews the definition and performance characteristics of the S&P 500® Single-Factor Indices, demonstrates their historical cyclicality and correlation, and presents a few examples of how market participants could potentially use investment vehicles tracking these single-factor indices as part of their own factor allocation, either as strategic or tactical plays. These examples expand the traditional asset allocation frameworks to factors, including optimal allocation frameworks, heuristic allocation frameworks, and a trend-based timing framework.

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