FACTOR INVESTING vs RISK-BASED STRATEGIES: SPOT THE DIFFERENCE

Factor-based investing – an alternative approach to cap-weighted indices
Factor-based investing focuses on identifying broad persistent characteristics for securities within a single asset class.  Factor-based indices ascribe weights to securities within an index based on those factor characteristics.
Factor-based indices are therefore typically single asset in nature, and represent an alternative approach to capitalisation weighted indices.
For example, Minimum Volatility equity index is typically constructed with a single asset class, e.g. equities whose constituents exhibit the lowest volatility characteristics.
Risk-based strategies – an alternative approach to multi-asset
When looking at multi-asset strategies, there are two approaches.
For asset-based investing, asset weights determine portfolio risk characteristics.
For risk-based investing, portfolio risk characteristics determine asset weights.
Risk-based indices are therefore typically multi-asset in nature, and represent an alternative approach to asset-based (e.g. 60/40) multi-asset indices.
For exanoke, a Minimum Variance index strategy targets the minimum variance multi-asset portfolio.
Risk-based multi-asset strategies therefore reflect a portfolio construction approach, rather than a factor screen.  It is the set of rules by which a multi-asset portfolio is optimised.
What are the advantages of a risk-based strategy?
The advantages of long-only risk-based index strategies are that they:
1.            Provide a systematic approach to risk management
2.            Can be constructed with liquid underlying ETFs
3.            Do not use leverage or shorting
 
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