Module 47.3 LOS 47.f: Uses of Multifactor models, tracking vs factor portfolios

We can use multifactor models for passive management, active management and in rule-based/algorithmic management

For passive management, managers often create tracking portfolios which track benchmarks. This is done constructing a set of factor exposures which match the benchmark. Active managers make bets on factors while hedging on other factors. A factor portfolio is constructed to do this. Algorithmic management uses rules to mechanically tilt factor exposures when constructing portfolios. These strategies introduce biases in the portfolio relative to value-weighted benchmark indices.

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