In part 1 of this article, we discussed the first three steps in analysing multifactor funds. Here we will continue with the remaining two steps.

4. How does the fund combine its targeted factors?
There are two main approaches to combining multiple factors in a portfolio: mixing and integration. Funds that follow the mixing approach split their portfolios into individual sleeves that each target a distinct factor. For example, if a fund uses the mixing approach to combine value and momentum, it might dedicate half the portfolio to targeting value stocks (ignoring their momentum characteristics) and the other half to momentum (ignoring value). This approach is similar to combining individual factor funds, but it offers the advantage of lower turnover by allowing trades to partially offset as stocks move across sleeves.

The mixing approach is simple, transparent, and facilitates clean performance attribution, making it easy to gauge the impact of each factor on the fund’s performance. That said, it can dilute the fund’s overall factor exposures because there is usually little overlap between the holdings in the different sleeves. For instance, stocks with strong value characteristics often have negative momentum, causing these factor exposures to partially offset in the combined portfolio.