Is Sector-Neutrality In Factor Investing a Mistake?

Investors who pursue factor investing face numerous choices—choices that don’t end once the set of factors they wish to invest in has been chosen. One of the choices is whether the factors should be sector neutralized. Ehsani, Harvey, and Li provided information that can help you make an informed decision. I would add that sector neutrality does reduce the risk of the behavioral problem of tracking variance (or error) regret. Thus, even though the research shows superior historical results for long-only portfolios that don’t consider sector neutrality, investors prone to that behavioral error might be willing to accept that trade-off.