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FRM Part II · FRM Exam Part II · Factor Theory

A manager builds a long-only multi-factor equity portfolio by combining separate single-factor sleeves (value, momentum, quality) versus an integrated approach that scores each stock on all factors and selects the highest composite scores. Which statement best describes the integrated approach?

The integrated approach scores each stock on all factors together, so it favors stocks with reasonably strong exposure to every factor. This captures interaction effects and avoids sleeves offsetting each other, such as buying a value stock with poor momentum in one sleeve and selling it in another.

  1. AIt tends to hold stocks with moderate exposure to every factor, capturing interaction effects that sleeves missCorrect
  2. BIt always has higher turnover than sleeves because of rebalancing across factors
  3. CIt requires factors to be uncorrelated with each other
  4. DIt holds stocks with extreme exposure to only one factor

Explanation

Composite scoring favors stocks scoring well across all factors, so it picks up cross-factor interactions and avoids holding stocks that are strong in one factor but weak in another, which sleeves can do and which may offset. It does not require zero correlation, and turnover is not always higher.

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