The Benefits of Multi-Dimensional Stock Selection Approaches

While the typical factor investors may be willing to gain exposure to risk factors through pure strategies and combine them into their own portfolio independently, researchers demonstrated that combining factor screening iteratively could be a more profitable risk-adjusted method. This entails that owning the top momentum stocks within the top profitable, within the top cheapest universe appears to have fueled better returns than owning top value, top profitability and top momentum equities within the universe over the 1991-2019 period and on a risk-adjusted basis.

This is quantified in the following piece of research¹  in which a systematic process is used to build pure, mixed and iterative equally weighted factors portfolios of European corporate equities. It finds that iterative methods yield better risk-adjusted returns than mixed and pure equally weighted factor portfolios over the long run. The paper also highlights that factor performance changes over time, with momentum becoming stronger through the sample period.

In conclusion, the power of effectively combining several risk factors exposure and the ordered structure of the factor filtering is a key part in the portfolio management. This method has delivered strong and statistically significant alpha from 1991 to 2019 and may continue to deliver it along with competitive risk-adjusted returns.

¹Bermejo, R., Figuerola-Ferretti, I., Hevia, T., & Santos, A. G. G. Y. (2021). Factor investing: A stock selection methodology for the European equity market. Heliyon, 7(10), e08168. https://doi.org/10.1016/j.heliyon.2021.e08168

Benoit Lahaye
Junior Investment Analyst

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