Bridge over ocean
20 March 2019 Financial Analysts Journal Volume 75, Issue 2

Transaction Costs of Factor-Investing Strategies

  1. Feifei Li
  2. Tzee-Man Chow
  3. Alex Pickard, CFA
  4. Yadwinder Garg, CFA

Although hidden, the implicit market impact costs of factor investing may substantially erode a strategy’s expected excess returns. The rebalancing data of a suite of large and long-standing factor-investing indexes are used in this study to model these market impact costs. A framework to assess the costs of rebalancing activities is introduced. These costs are then attributed to characteristics that intuitively describe the strategies’ demands on liquidity, such as rate of turnover and the concentration of turnover. A number of popular factor-investing implementations are identified, and the authors discuss how their index construction methods, when thoughtfully designed, can reduce market impact costs.

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