Transaction Cost–Optimized Equity Factors around the World

Abstract

Firm characteristics like value, momentum, or quality help explain the cross-section of stock returns and have become core pillars in the practice of factor investing. However, when practically implementing factor strategies, transaction costs can significantly impact the corresponding factor portfolios’ performances. Using proprietary trading data from a large institutional asset manager, we construct a realistic transaction cost model to investigate how to optimally implement factor portfolios with transaction costs. We provide a framework to optimize factor performance net of transaction costs, but do not overly sacrifice factor exposure at the expense of lower transaction costs. We show that our analysis can be readily extended to a multi-factor setting