Sector or factor? Unveiling the winning investment strategy in China

This study investigates the performance difference between factor- and sector-based investment strategies. Specifically, we construct portfolios based on 10 Chinese stock market sub-industry sectors and five investable factor indices under a variety of different weighting optimization models. The optimization algorithms we choose are the equally weighted, risk parity, minimum variance, mean-variance, Bayes-Stein, and Black-Litterman models. The empirical results show that factor allocation outperforms sector allocation in terms of both risk and return over the full sample period, and factor portfolios do not produce greater tail risk. However, during periods of financial market turbulence, sector allocation provides relatively better risk diversification opportunities. We also find that the above performance differences are sensitive to investment environments such as estimation window length and position constraints. We conclude that factor allocation provides an attractive investment option for investors, regardless of its relatively shorter history of indices.