Factor Allocation 101: Equal vs Volatility-Weighted

Simplicity Beats Complexity

September 2017. Reading Time: 10 Minutes. Author: Nicolas Rabener.


  • Equal-weight and volatility-weighted allocations are two common factor allocation frameworks
  • Risk-return ratios are not higher with volatility-weighted allocations
  • Different reasons can explain the superiority of equal-weight allocations


In July we published a research report “Factors & Volatility-Based Risk Management” were we analysed Value, Size and Momentum based on Fama-French data and concluded that higher factor volatility is not necessarily negative for the risk-return ratios of factors. We decided to have another look and enhance the analysis by adding more factors and adopting a constant volatility target (aka risk parity model). In this short research note we will analyse the differences between equal-weight and volatility-weighted multi-factor portfolios in the US, Europe and Japan.


We’re going to focus on six factors: Value, Size, Momentum, Low Volatility, Growth and Quality in the US, Europe, and Japan. The factors are constructed as beta-neutral long-short portfolios by taking the top and bottom 10% of the stock universes. Only companies with a minimum market capitalization of $1bn are considered and 10bps of transaction costs are included. The multi-factor portfolios are rebalanced annually.

The volatility-weighted portfolio targets a constant volatility of 14% in the US and Europe and 16% in Japan for each factor. The volatility targets are based on matching the volatility profiles of both multi-factor portfolios. The volatility-weighting, which implies that a factor can get allocations of more or less than 100% of capital, is conducted quarterly and incurs a transaction cost of 10bps. We ignore financing costs that would be charged from levering up factors below the target volatility, which means that the volatility-weighted performance is slightly overstated.


The chart below shows the performance of the equal-weight and volatility-weighted multi-factor portfolios for the US from 2000 to 2017. We can observe that the equal-weight portfolio significantly outperforms the vol