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FRM Part II · FRM Exam Part II · Portfolio Construction

An asset owner compares two ways of combining value, momentum and quality factors: (1) mixing separate single-factor portfolios, and (2) building one portfolio that screens each stock on all three factors simultaneously. Which statement is most accurate?

The integrated approach tends to capture stocks with joint factor exposures and avoids offsetting positions. In a mix of single-factor portfolios, one sleeve's holdings can cancel another's tilt and add trading costs, whereas screening on all factors together delivers more efficient net factor exposure.

  1. AThe integrated approach tends to capture stocks with joint exposures and avoid holding offsetting factor positions that cancel each otherCorrect
  2. BThe mixing approach always gives higher net exposure to each factor than the integrated approach
  3. CThe two approaches give identical holdings if factors are uncorrelated
  4. DThe integrated approach cannot control for turnover

Explanation

In a mix, one sleeve may hold a stock that another sleeve is short or underweights, so exposures partially offset and costs are incurred. An integrated approach picks stocks scoring well across factors, giving more efficient net exposure. The other options are unsupported: mixing does not always give higher exposure, holdings differ even with uncorrelated factors, and integrated approaches can manage turnover.

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