By: Andy Dougan, director, research and analytics
Factor Index construction is a topic widely discussed at the moment. A major area of debate concerns the construction of multi-factor indexes. Should construction be top-down where separate single factor indexes are created and then combined by averaging weights? Or should the construction be bottom-up where a single integrated top-down portfolio is formed by weighting stocks in consideration of their all factor characteristics simultaneously? In this theoretical paper we consider three approaches, one top-down and two bottom-up, that shed some light on this dilemma.