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The Sum of the Parts Are there advantages to combining single factor indices?
BY Fei Mei Chan

INTRODUCTION


Index-based investing has enjoyed significant growth in the past 20 years, and has evolved from simply benchmarking and replicating the broad market to indexing factors. We use the term “factor” to denote a quality or attribute with which excess returns (or at least excess risk-adjusted returns) are thought to be associated. Defensive factors such as low volatility gained particular prominence in the aftermath of the 2008 financial crisis. In the time since, other factors have also attracted attention, and factor-based investing has proliferated in terms of both the number of products based on factor indices and in assets tied to those vehicles globally.

Given the success of strategies that exploit single factors, it is not surprising that strategies designed to exploit more than one factor have begun to pique the interest of market participants. If two factors work independently, they might also work well in combination. This paper will explore a framework in which factors can be analyzed for their potential contribution as a piece of the whole.

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