A practitioner's view of the long-term and recent performance of multifactor investment strategies

In this paper we study the performance of factor investment strategies from a practitioner's point of view. We first create a multifactor portfolio called the factor-tilted benchmark (FTB) using risk parity factor allocation. The FTB is created without practical considerations. We then examine the impact on historical performance by adding practical constraints to the FTB, such as no short selling, low portfolio turnover and low tracking error to the market capitalization benchmark and a limited number of portfolio holdings. We show that in the long term multifactor portfolios in major equity markets still earn excess returns above those of the market with these practical constraints net of transaction costs. We then focus on the recent disappointing performance of factor investing by estimating the probability of experiencing the recent performance or worse outcomes given prior history. While both the FTB and factor portfolios with practical constraints have fallen short of delivering their historical long-term outperformance in the last few years, factor portfolios with constraints have shown smaller performance slippage, and their recent performance looks more probable than the FTB based on prior history. We advocate setting performance expectation on factor investment strategies using factor portfolios with practical constraints.