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Exploring Techniques in Multi-Factor Index Construction What portfolio construction choices are available to those seeking multi-factor approaches?
BY Akash Jain

In multi-factor equity index construction, the decision-making and practical implementation can be complex and challenging. This paper examines the range of portfolio construction choices available to those seeking rank-based, multi-factor approaches, and the relative advantages of each.

Through back-testing hypothetical portfolios based on the S&P 500®, this paper evaluates the following construction choices: top-down versus bottom-up; sector-neutral versus sector-agnostic; portfolio concentration; weighting scheme; and rebalancing frequency. To measure the effectiveness of each portfolio, a factor efficiency ratio (FER) is proposed, which allows investors to gauge their factor purity without having to invoke the complexity of a risk model.

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