Combining Factors in Multifactor Portfolios
Reschenhofer’s findings demonstrate the important role that portfolio construction rules (such as creating efficient buy and hold ranges or imposing screens that exclude stocks with negative momentum) play in determining not only the risk and expected return of a portfolio but how efficiently the strategy can be implemented (considering the impact of turnover and trading costs)—wide (narrow) thresholds reduce (increase) portfolio turnover and transactions costs, thereby increasing after-cost returns and Sharpe ratios. His findings also provide support for multiple characteristics-based scorings to form long-only factor portfolios, encouraging the combination of slow-moving characteristics (such as value, investment and/or profitability) conditional on fast moving characteristics (such as momentum), to reduce portfolio turnover and transactions cost. Fund families such as AQR, Avantis, Bridgeway and Dimensional use such an approach, integrating multiple characteristics into their portfolios conditional on momentum signals.
