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Bridging the gap: Adding factors to indexed and active allocations

Asset owners face a challenge in determining how the factor allocation fits into the overall equity program, in particular how the factor allocation relates to the existing roster of active managers. This paper uses a risk budgeting framework to investigate how active mandates and factor allocations can be combined. We address three key questions: 1) how does the level of active risk in active management affect the factor allocation decision, 2) what share of the portfolio can be deployed to the factor allocation and 3) what are the implications of a top-down versus a bottom-up factor allocation.