I remember when multi-factor strategies became popular 15 years ago. They were marketed to add more diversification than the market while capturing the known risk premia – value, momentum, quality, volatility, and size – and were considered “smart beta.”
I spoke with two advisors the other day that said they moved away from these strategies as some have been significantly underperforming the market. The chart below supports this view.
Various Multi-Factor Strategies (8/1/23 to 7/31/25)
The names and tickers above have been removed to protect their identities. Very few of those displayed have kept up with the S&P 500 (bold orange line) over the last two years. One strategy (bold red line) has underperformed by a whopping 25%. We believe this is unacceptable to investors and mischaracterizes the value that multi-factor investing can bring.
We believe it’s possible to have a multi-factor approach without being overly concentrated in positions, sectors, or styles, but also letting the factors that are working well to perform. We believe it’s possible to have return enhancement and risk mitigation at the same time. The bold black line illustrates that this is possible.
We also believe that the process doesn’t have to be an enhanced index approach. It can be supportive of active management. Yes, in a 60-stock portfolio, there will be some idiosyncratic risks, but that doesn’t negate the quantitative-driven bottom-up process. When trend is integrated as a factor with value, momentum, volatility, and quality, we believe that can also enhance returns while simultaneously reducing risk. This is because trend takes on many forms – reversals (value, mean reversion, momentum), stable trends (low volatility), and breakouts (momentum). Ideally, most positions in the portfolio will have 2 or more factor universes that they belong to.
I believe we have a distinct approach that brings the elements and discipline of active management, quantitative investing, and trend-following all together and without needing to hold 200-400 securities, like some multi-factor strategies do. Risk is managed by sector and factor constraints but also by position sizing.
There are different thoughts on position sizing. Some suggest limiting the position size to the volatility of the position, which makes a lot of sense if the primary goal is risk management. Others believe that you should let your winners run as far as possible while systematically cutting losers. This works if your goal is to have the highest possible performance, without concern for concentration and risk.
We believe a balanced approach makes sense. It can allow for competitive returns while managing risk. Limiting positions to 1-2% of the portfolio and regular rebalancing allows for less concentration than the market, that now has position sizes of 8%, 7%, 6%, and 4%, respectively, for the four largest positions.
We have no issues with the 1.0 versions of multi-factor or “smart beta,” but we believe we can be smarter. It’s time to unshackle the quants to look at multi-factor investing in a newer, more actively managed light that includes trend, allows factors to float some (factor momentum), and that doesn’t require 200-400 stocks.