Bottom-Up Approach of Portfolio Construction: An Application of Style-Investing

Abstract

Style investing is one in which securities are classified based on some common characteristics in such a manner that assets in each group appear to be similar. When we discuss equity-based style investing, these styles may range from value and size to momentum and quality. Style investing can be defined as a rule based method of investing that generates unique long-term positive average returns across market and asset classes, with a low to zero correlation with o long-only asset classes. The present study is an attempt to examine the performance of the strategy of constructing single-style portfolios using Value and Momentum factors and also constructing a portfolio by combining Value and Momentum styles into a single portfolio using the bottom-up approach. In addition, the portfolios were rebalanced annually. Furthermore, the constructed portfolios were assessed on different risk and return parameters such as CAGR, max-drawdown, volatility, information ratio, tracking error and so on. The research indicates that integrating a specific style into a portfolio can enhance performance by yielding higher returns in exchange for the additional risk assumed. Moreover, it highlights that adopting a bottom-up approach to combining styles not only streamlines the process but also allows investors to gain exposure to multiple styles at once, thereby providing diversification benefits.

Keywords: Factor Investing, Momentum, Portfolio Construction, Style, Value, Multi-Factor, Investment Strategy

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