Design Choices and Risk Factor Performance

Two Sigma

Research

21 Pages

Two Sigma explores how subtle construction decisions materially change the performance of risk factor strategies, even when targeting the same factor. The authors show that implementation details can swing outcomes significantly, with some variations producing materially different Sharpe ratios despite identical factor definitions.

Key Takeaways

Implementation Drives Returns Variations in portfolio construction led to Sharpe ratios ranging from ~0.2 to over 0.8 for the same low-risk factor.
Turnover Impacts Performance Higher turnover versions of the strategy exceeded 100% annually, materially reducing net returns after transaction costs.
Weighting Scheme Matters Equal weighting versus volatility scaling produced return differences exceeding 2% annually across tested factor portfolios.
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