Factor investing can be about diversifying risk; and no, the market portfolio is not the “most diverse” portfolio. The market is priced by the average of all risk assessments; the goals and measure of risk are different, so there will be tilts that are more diversified in the number/size of risk sources.Factors haven’t been giving positive returns recently in the US. And factor investing isn’t about diversifying risk, it’s about concentrating and increasing risk, with the hopes of increasing return. The factor portfolio has stocks that all have the same factor characteristics.However, assuming that you do have a cheap fund with strong factor loadings and factors do end up continuing to provide positive returns, then I suppose that having a below 100% loading on Mkt-RF would probably end up providing long-term returns equal to Mkt-RF returns but with less overall volatility since different factors (Mkt-RF, SMB, etc.) would kick in at different times and each balance out sp that you aren't just exposed to the swinginess of the Mkt-RF factor.
The market portfolio is the most diverse with a mix of all the different characteristics.
The market portfolio does not attempt to size risk sources equally or in any risk-managed manner; it is just the composite risk appetite, and some risk sources will be inevitably larger than others.
Is it right to size these risk sources differently than the market? It depends on one’s objectives. Those seeking a smoother ride would want to size the risk sources more equally via a tilt in a manner that reduces volatility. Those seeking a higher octane ride might do the opposite tilt to obtain a higher upside potential. Who is doing this wrong? The answer is neither.
Statistics: Posted by secondopinion — Mon Mar 10, 2025 2:55 am