Transaction Costs of Factor Strategies
We present a very important academic paper written by Li, Chow, Pickard and Garg, which shows that market impact and costs related with a rebalancing of factor strategies can be very significant if not properly managed …
Shortly:
“Although hidden, implicit market impact costs of factor investing strategies may substantially erode the strategies’ expected excess returns. The authors explain these market impacts costs and model them using rebalancing data of a suite of large and longstanding factor investing indices. They introduce a framework to assess the costs of rebalancing activities, and attribute these costs to characteristics such as rate of turnover and the concentration of turnover, which intuitively describe the strategies’ demands on liquidity. The authors evaluate a number of popular factor-investing strategy implementations and identify how index construction methods, when thoughtfully designed, can reduce market impact costs. “
