Constructing Long-Only Multifactor Strategies: Portfolio Blending vs. Signal Blending

Long-only multifactor strategies may be constructed by combining individual-factor portfolios (portfolio blending) or by combining individual-factor signals into a composite signal to construct the portfolio (signal blending). To compare these two approaches, we present a framework for building exposure-matched portfolios. In empirical tests on global equity markets, we find that, generally, portfolio blending generates higher information ratios for low-to-moderate levels of tracking error. At high levels of tracking error, signal blending delivers better risk-adjusted performance. These results generally hold for various factor combinations, and they have important practical implications for investors considering the implementation of multifactor smart-beta strategies.