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Aligning factor attribution with latent exposures

Author

Listed:
  • Sanne De Boer

    (QS Investors)

  • Vishv Jeet

    (The Burgiss Group)

Abstract

We customize factor attribution for quantitative equity portfolios to better align the measurement of factor returns with how factor tilts were taken on. Specifically, we provide a theoretical argument for including the absolute value of factor exposures in the attribution to account for the impact of a long-only constraint, as well as intuition for including lagged factor exposures in the presence of turnover limits. This may reduce any long-term unexplained performance resulting from priced distortions of unconstrained factor tilts. In addition, we find that targeting the most accurate estimates of factor returns irrespective of investment constraints can amplify the impact of stock-specific risk on performance attribution. Instead, restricted least squares estimates of the factor returns may retain good accuracy while letting factor attribution explain short-term portfolio performance in full, based on minimally adjusted factor-mimicking portfolios that span the portfolio under consideration. We report back-tests of quantitative equity strategies that confirm our intuition, and suggest diagnostics for portfolio managers who consider adopting the proposed attribution framework.

Suggested Citation

  • Sanne De Boer & Vishv Jeet, 2016. "Aligning factor attribution with latent exposures," Journal of Asset Management, Palgrave Macmillan, vol. 17(7), pages 502-525, December.
    • Handle: RePEc:pal:assmgt:v:17:y:2016:i:7:d:10.1057_s41260-016-0001-z
    DOI: 10.1057/s41260-016-0001-z
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    References listed on IDEAS

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    1. Sanne de Boer, 2012. "Factor attribution that adds up," Journal of Asset Management, Palgrave Macmillan, vol. 13(6), pages 373-383, December.
    2. Harrison Hong & Terence Lim & Jeremy C. Stein, 2000. "Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies," Journal of Finance, American Finance Association, vol. 55(1), pages 265-295, February.
    3. Ravi Jagannathan & Tongshu Ma, 2003. "Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps," Journal of Finance, American Finance Association, vol. 58(4), pages 1651-1683, August.
    4. Anureet Saxena & Chris Martin & Robert A Stubbs, 2013. "Constraints in quantitative strategies: An alignment perspective," Journal of Asset Management, Palgrave Macmillan, vol. 14(5), pages 278-292, October.
    5. Bruno Durin, 2014. "Signal-wise performance attribution for constrained portfolio optimisation," Papers 1404.4798, arXiv.org, revised Aug 2014.
    6. Ravi Jagannathan & Tongshu Ma, 2003. "Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps," Journal of Finance, American Finance Association, vol. 58(4), pages 1651-1684, August.
    Full references (including those not matched with items on IDEAS)

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