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Blending Factors in Smart Beta Portfolios Are two factors better than one?
BY Tianyin Cheng

In recent years, smart beta strategies have seen a significant increase in popularity. These systematic strategies seek to measure factors in order to harvest the associated long-term risk premium. Many empirical studies show that smart beta strategies have historically outperformed their cap-weighted benchmarks. However, different single factors tend to outperform in different market environments. Therefore, holding a combination of factor strategies in a blended portfolio could provide a powerful source of diversification and more stable excess returns.

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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