Abstract
Many quant equity portfolio managers (PMs)’ factor-ranking processes are motivated by the Fama-French model (FF) (Fama and French, 1992 & 1993). The FF model espouses the use of stock characteristics for stock screening and portfolio construction. We see the following issues with this approach: -
- Dangerous hidden assumption: factor yields positive return.
- Lack of vision about future factor return.
- Loss of distance information.
- Inefficiency in allocation decisions.
This article discusses the nature of the above issues, explores the sources of them, and presents a logical thought process leading to the Augmented Black-Litterman (ABL)-based solution.
Of particular interest is that our analysis is linked to the style rotation discussion, and explains why some systematic strategies driven by the FF factor screening approach is supposed to make systematic losses in a market change, e.g., the August 2007 credit crunch.
- Dangerous hidden assumption: factor yields positive return.
- Lack of vision about future factor return.
- Loss of distance information.
- Inefficiency in allocation decisions.
This article discusses the nature of the above issues, explores the sources of them, and presents a logical thought process leading to the Augmented Black-Litterman (ABL)-based solution.
Of particular interest is that our analysis is linked to the style rotation discussion, and explains why some systematic strategies driven by the FF factor screening approach is supposed to make systematic losses in a market change, e.g., the August 2007 credit crunch.
| Original language | English |
|---|---|
| Publisher | Lehman Brothers |
| Publication status | Published - 2008 |