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Combining Factors

advanced7 min read

Factors zig and zag at different times — blending them smooths the ride. The intuition behind multi-factor.

No single factor works all the time — each has long stretches of underperformance. The capstone idea of factor investingTilting a portfolio toward traits that have historically paid. is combining multiple factorsTilting a portfolio toward traits that have historically paid. into a multi-factor portfolio, so their good and bad periods partly offset.

Combining factorsTilting a portfolio toward traits that have historically paid. is *diversificationSpreading money across assets that don’t move together to cut risk. applied to edges themselves — and it works because *factorsTilting a portfolio toward traits that have historically paid. are imperfectly correlatedHow closely two assets move together.*, often performing well at different* times. Value can languish for years exactly while momentumBuying recent winners and avoiding recent losers. soars; momentumBuying recent winners and avoiding recent losers. can crash precisely when value and quality hold firm. By blending them, the blend’s ride is far smoother than any single factor’s, because one factor’s drought is cushioned by another’s feast. This is the same “only free lunch” (diversificationSpreading money across assets that don’t move together to cut risk.) from the investing track, now applied to return drivers instead of individual stocks — and it’s even more powerful here, because the whole point of holding several factors is that they’re designed to zig and zag against each other. Practically, you can blend by mixing factor sleeves or by selecting stocks that score well across several factors at once (e.g. cheap and high-momentum and high-quality). The result: a more robust, more holdable strategy — and holdability is what lets you actually capture the long-run premia, since you’re far less likely to abandon a diversified blend during any one factor’s painful spell.
ExampleA portfolio split across value, momentumBuying recent winners and avoiding recent losers. and quality rides far smoother than any one alone: in a growth mania value lags but momentumBuying recent winners and avoiding recent losers. carries it; in a momentum crash value and quality cushion the blow. The blend’s drawdowns are shallower, so the investor actually holds on — and capturing the long-run premia depends entirely on holding on.
Key takeawayNo factor works all the time, so combine several — value, momentumBuying recent winners and avoiding recent losers., quality, low-volThe size of price swings — not their direction. — that are imperfectly correlatedHow closely two assets move together. and shine at different times. It’s diversificationSpreading money across assets that don’t move together to cut risk. applied to edges, smoothing the ride so the strategy is holdable. Blend factor sleeves, or pick stocks scoring well across factorsTilting a portfolio toward traits that have historically paid. at once.
FAQs
How many factors should I combine?

A handful of well-understood, imperfectly-correlated factors (e.g. value, momentum, quality, low-vol) is usually plenty — enough to diversify their cycles without over-complicating the strategy (recall: parsimony). Adding many marginal or overlapping factors invites overfitting and complexity for little extra diversification. Favour a few robust, complementary factors with real rationales.