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Minimum Correlation Factor Portfolios

The lower the factor correlation, the better?

Nicolas Rabener
10 min read
11 Mar 2020

SUMMARY

  • Minimizing factor correlations is a common approach to creating multi-factor portfolios
  • However, the diversification benefits from minimizing the correlations of long-only two-factor portfolios were marginal
  • This suggests that investors should not focus too much on correlations when combining smart beta strategies

INTRODUCTION

The two basic of rules of asset allocation are: i) identify assets with positive expected payoffs, and ii) ensure that the assets are not too highly correlated, so that diversification benefits can be harvested. Although the rules are simple, implementation is often complex.

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