FRM Part II · FRM Exam Part II · Factors
A fund manager compares two ways of building a multi-factor equity portfolio: (A) mixing separate single-factor portfolios (portfolio mix), and (B) selecting stocks on a composite of all factor scores (signal mix). Factor exposures are partly offsetting at the stock level, for example stocks that score high on value tend to score low on momentum. Which statement is most accurate?
Signal mix generally yields stronger combined factor exposure when factors conflict at the stock level, because it picks stocks scoring acceptably on several factors. Portfolio mix holds separate extreme stocks whose exposures partly offset, diluting integrated exposure. The two methods are not equivalent.
- ASignal mix tends to deliver stronger net exposure to the intended factors because it favors stocks that score reasonably well on several factors, whereas portfolio mix can dilute exposure through offsetting holdingsCorrect
- BPortfolio mix always gives higher exposure because it holds more stocks
- CSignal mix and portfolio mix are mathematically identical in all cases
- DSignal mix removes all factor correlation and so cannot be affected by offsetting exposures
Explanation
With negatively related factor scores, a composite score picks stocks that are decent on both, giving better combined exposure. A portfolio mix holds high-value-low-momentum and high-momentum-low-value stocks separately, so exposures partly cancel at the total level. The approaches are not identical, and signal mix does not eliminate correlation.
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