Factor ETFs -  Risk Exposure and Diversification Benefits

Abstract: This paper analyzes U.S. factor ETF risk exposures and diversification benefits relative to the ETFs’ academic factor portfolios. The purpose of the paper is to observe whether the factor ETFs’ correlations and risk exposures reflect that of their academic factor portfolios, the long-short and long-only portfolios. The results exhibit the market factor as the fundamental agent of returns, although size, value, and momentum also provide exposure to the intended factors. When measuring the loadings of factor ETFs and their intended factor portfolios, the long-short investing approach provides the most optimal diversification strategy.