Downside risk of investment factors

The table reports downside risk characteristics of factor portfolios. Both the long-only side and the long-short factor portfolios are shown broken down by large and small cap stocks. By netting out market effects, the long-short portfolios give us a clearer view of the downside risk characteristics of the factors themselves, which directly translates into out- or underperformance relative to the benchmark for a long-only investor. The table represents an important illustration of the fact that we cannot get rid of risk, but we can chose which risk we want to take. Take for example the ‘low beta’ factor for large caps which has had the lowest absolute downside risk (-37% worst drawdown), but the highest relative risk (-76%) as illustrated by the long-short portfolio. And, the absolute underperformance was the shortest at 3.4 years, but the relative underperformance lasted more than 24 years!