Pure Quintile Portfolios

Ding Liu
AllianceBernstein
March 30, 2016

dingliu001@gmail.com

Abstract
In this paper we propose a new portfolio construction framework called Pure Quintile
Portfolios. These portfolios overcome the main drawback of nave quintile portfolios
based on single sorts, namely, not having pure exposures to the target factor. Each pure
quintile portfolio has the same exposure to the target factor as its nave counterpart, but
also has zero exposures to all other factors. Therefore pure quintile portfolios more
accurately reflect the cross sectional distribution of true factor returns. In addition, when
we long Q1 and short Q5 to capture factor premia as is most commonly done in research
and practice, we find that pure Q1-Q5 portfolio has lower risk and higher Sharpe ratio
than nave Q1-Q5 portfolio for a group of widely used factors, thus providing evidence
that our new framework creates more efficient and stable factor premia than nave
quintile portfolios.

1
Electronic copy available at: http://ssrn.com/abstract=2755756

1) Introduction
It is well known that equity returns are driven to a large extent by factors such as Value
and Size (Fama and French 1992, 1996). A common way to evaluate the efficacy of a
factor is to form quintile portfolios by sorting on that factor. It is also common to long Q1
short Q5, and use the resulting market-neutral portfolio to capture the factor return. These
nave quintile portfolios are intuitive and easy to construct, but they dont represent
pure exposures to the factor. For example, the top quintile portfolio by book-to-price
outperforms the bottom quintile over the long run, but high book-to-price stocks
generally also have smaller market caps and lower balance sheet accruals than low bookto-price stocks, and therefore more exposed to the small cap effect (Banz 1981) and the
accruals effect (Sloan 1996). It is not clear how much of the nave Q1-Q5 portfolio return
is due to its book-to-price versus market cap or balance sheet accruals exposures. So,
nave Q1-Q5 portfolio by sorting book-to-price does not reflect the efficacy of a pure
book-to-price factor.
Besides masking the true factor efficacy, nave Q1-Q5 portfolios often suffer from
offsetting effects from unintended factor exposures that wash out the intended factor
performance. For example, performance of high book-to-price stocks (i.e. Value) is hurt
by their negative exposures1 to Momentum, which has positive return over the long run.
Likewise, high Momentum stocks do not realize the full outperformance of pure
Momentum because of wash-out from negative Value exposures. Therefore it should be
possible to improve the performance of both factors simultaneously by disentangling
interactions between them. There are also other benefits of pure factor returns such as
they are more predictable than nave factor returns and are additive (Jacobs and Levy
1989).
One way to disentangle factors is two-way sort (Basu 1983). For example, to create
Value quintile portfolios with roughly the same Momentum exposures, first sort by
Momentum and form quintile portfolios. Next, within each Momentum quintile sort by
Value and form the next level quintile portfolios (called buckets). Then take the highest
Value bucket from each Momentum quintile and combine them as new Value quintile
one, take the second highest Value bucket from each Momentum quintile and combine
them as new Value quintile two, and so on. These new Value quintiles have
monotonically lower Value exposures, but similar Momentum exposures because each
one draws one-fifth of its stocks from every Momentum quintile. However, this method
does not generalize well to multiple factors: with 5 factors it would create 3125 buckets,
way more than the number of large cap stocks in the U.S. Another limitation is that it
does not disentangle factors completely: these new Value quintiles have similar but not
exactly the same Momentum exposures.
Another way to disentangle factors is to run multivariate regressions (Jacobs and Levy
1988, 1989, Back, Kapadia and Ostdiek 2013). Let X be the matrix of standardized factor
1

In this paper we standardize factor exposures across all stocks by subtracting the equally-weighted
average and dividing by the cross-sectional standard deviation, so negative exposure means below average.

2
Electronic copy available at: http://ssrn.com/abstract=2755756

exposures (e.g. standardized book-to-price, market capitalization) and r the vector of

excess returns over all stocks in a universe such as the Russell 1000 index2.
Regressing r against all column vectors of X simultaneously gives ( X ' X ) 1 X ' r , which
can be interpreted as returns of the standardized factors. The row vectors
of ( X ' X ) 1 X ' define a set of portfolios that mimic these factors (called Factor-Mimicking
Portfolios or FMPs). Because (( X ' X ) 1 X ' ) X I , each FMP has one unit of exposure to
a single factor and zero exposures to all other factors, and therefore represents pure
exposure to that factor. Alternatively, the same FMPs can be created by optimizations:
consider minimizing w' w subject to X ' w ei , where ei is a k by 1 vector with one on
the i -th positon and zeros elsewhere. It is easy to show that the solution of this
optimization is the i -th row of ( X ' X ) 1 X ' (see Grinold and Kahn 2000).
We adapt and extend this FMP optimization framework to create pure quintile portfolios.
In previous research (for example, Melas, Suryanarayanan and Cavaglia 2010),
optimization is used to create only one FMP per factor, typically a long-short marketneutral portfolio with one unit of standardized exposure to that factor. We adapt the
optimization in a number of ways: 1) for each target factor we run 5 optimizations to
create 5 long-only portfolios called pure quintile portfolios; 2) in each optimization we
set the number of stocks in the pure quintile portfolio to be the same as a nave quintile
portfolio; 3) in each optimization we set the pure quintile portfolios exposure to the
target factor to be the same as the corresponding nave quintile portfolio; 4) in each
optimization we set the pure quintile portfolios exposures to all other factors to zero. As
a result, pure quintile portfolios have the same number of stocks and span the same cross
section of exposures to the target factor as nave quintile portfolios, but also have zero
exposures to all non-targeted factors. Therefore they represent a spectrum of pure
exposures to the target factor. We are not aware of any previous studies that have done
this, which is the first contribution of this paper.
As the second contribution of this paper, we found that when pure quintile portfolios are
created in the US large cap universe using a set of simple and commonly used factors,
pure Q1-Q5 portfolios have substantially higher Sharpe ratios than nave Q1-Q5
portfolios across all factors. Interestingly, this is driven by both risk reduction and return
enhancement. Each pure Q1-Q5 portfolio has lower risk, and with the exception of one,
higher return than nave Q1-Q5 portfolio. Looking at each Q1 and Q5 separately, we
found that almost every pure quintile portfolio has lower risk than its nave counterpart
(which is also true for Q2, Q3 and Q4). The higher return of pure Q1-Q5 portfolio comes
from both long and short sides. That is, pure Q1 has higher return than nave Q1, and
pure Q5 has lower return than nave Q5. This is evidence that our pure quintile
methodology creates stronger and more stable Q1-Q5 factor returns than nave quintile
sorts. Similar evidences exist in Developed International and Emerging Market stocks,
albeit weaker than in the US.

Assume there are n stocks and k factors, then X is a n by k matrix and r is a n by 1 vector.

The rest of this paper is organized as follows. The next section describes data and
demonstrates unintended factor exposures in nave quintile portfolios. Then, the pure
quintile portfolio framework is described and their performances are compared with
nave quintile portfolios in the US large cap universe. Afterwards, we repeat the analysis
in Developed International and Emerging Market stocks. This is followed by some brief
concluding remarks.

2) Data and Factor Exposures of Nave Quintile Portfolios

In this paper we focus on five factors: Value, Size, Price Momentum, Profitability and
Earnings Quality. We choose these factors because they are all well-known, extensively
studied in the literature, and widely used in practice. To define these factors, we use
book-to-price for Value, the natural log of market capitalization for Size, 11 month past
price return lagged by 1 month for Price Momentum, return-on-equity for Profitability,
and balance sheet accruals3 for Earnings Quality. These factor definitions are simple and
fairly standard. There are many other ways of defining these factors4, but here we are not
interested in fine-tuning factor definitions to make the most economic sense or to realize
the best performance. This paper is focused on demonstrating the pure quintile portfolio
framework and comparing performance with nave quintile portfolios, and for that
purpose we prefer simple definitions.
Every month from January 1979 to December 2014, we collect these factors for all stocks
in the Russell 1000 index from AllianceBernsteins internal equity research database,
which in turn gets the raw data from multiple sources including Compustat, CRSP, and
Russell. We choose the Russell 1000 universe because it is widely used by institutional
managers as a barometer for US large cap investments. Table A1 in the appendix shows
the number of stocks in Russell 1000, those with data on each factor, and those with data
on all factors at the beginning of each year. To create nave and pure quintile portfolios of
each factor, we use all stocks with data on that factor, even though some of them miss
data on other factors. We have repeated the analysis using only stocks with data on all
five factors, and the results are very similar.
Following common practice, every month for every factor we first winsorize its raw
values at 5% and 95% levels, and then standardize them by subtracting the equallyweighted average and dividing by the cross-sectional standard deviation. We call these
standardized factor values exposures. Because of standardization, exposures are
comparable across factors and across months. Throughout this paper, we use market to
mean the equally weighted portfolio of all stocks, which has zero exposures to all factors
because of standardization. Therefore a portfolio with exposure of one to Value, for
example, means that its weighted average book-to-price is one standard deviation above
the market. For Value, Profitability and Price Momentum, higher factor exposures have
3

Balance sheet accruals is calculated as one year change of asset accruals minus liability accruals, divided
by average total assets, where asset accruals is total assets minus cash and short term investments, and
liability accruals is total liabilities minus debt in current liabilities and total long term debt.
4
For example, Value is sometimes defined as a combination of book-to-price, earnings-to-price and
dividend yield.

higher expected returns; but for Size and Earnings Quality the opposite is true because
stocks with smaller market cap and lower balance sheet accruals tend to outperform. For
consistency, we flip the signs of Size and Earnings Quality exposures so that in all cases
higher exposures have higher expected returns. Nave quintile portfolios are then created
every month by sorting on these factor exposures, with quintile one having the highest
exposure and quintile five having the lowest exposure, and stocks equally weighted
within each quintile.
The left side of Table 1 shows average standardized factor exposures of nave quintile
portfolios from 1979 to 2014. It is clear that they all pick up unintended factor exposures
to some degree on average. For example, stocks in Value Q1 have smaller market caps,
lower recent past returns, lower profits, and lower balance sheet accruals than other
stocks. These unintended exposures are not driven by some extreme correlations between
Value and the other factors during a short period of time. In fact they are generally
persistent over time: Figures 1 and 2 show the rolling 12 month average factor exposures
of Value nave Q1 and Q5.
Figure 1.

Figure 2.

Table 1. Average Standardized Factor Exposures of Nave and Pure Quintile Portfolios, 1979 2014

Value Naive Quintiles

Q1
2
3
4
Q5

Value Pure Quintiles

Value

Size

Price
Momentum

Profitability

Earnings
Quality

1.58
0.46
-0.17
-0.68
-1.19

0.21
0.07
-0.03
-0.13
-0.18

-0.48
-0.17
-0.01
0.16
0.50

-0.68
-0.31
-0.06
0.30
0.78

0.20
0.12
0.03
-0.11
-0.26

Q1
2
3
4
Q5

Value

Size

Price
Momentum

Profitability

Earnings
Quality

1.58
0.46
-0.17
-0.68
-1.19

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

Size Naive Quintiles

Q1
2
3
4
Q5

Value

Size

Price
Momentum

0.21
0.06
-0.03
-0.03
-0.21

1.17
0.70
0.20
-0.47
-1.59

-0.30
0.02
0.10
0.08
0.09

Size Pure Quintiles

Profitability

Earnings
Quality

-0.21
-0.08
-0.03
0.05
0.26

-0.04
-0.03
-0.03
0.05
0.05

Q1
2
3
4
Q5

Price Momentum Naive Quintiles

Q1
2
3
4
Q5

Value

Size

Price
Momentum

Profitability

Earnings
Quality

-0.50
-0.16
0.04
0.20
0.43

-0.05
-0.15
-0.11
-0.01
0.27

1.53
0.42
-0.11
-0.58
-1.27

0.19
0.13
0.05
-0.04
-0.30

-0.10
0.04
0.08
0.05
-0.06

Q1
2
3
4
Q5

Value

Size

-0.86
-0.37
0.12
0.59
0.58

-0.26
-0.15
0.01
0.07
0.26

0.22
0.10
0.02
-0.12
-0.24

Q1
2
3
4
Q5

Q1
2
3
4
Q5

Value

Size

0.14
0.21
0.08
-0.11
-0.29

0.06
-0.10
-0.12
-0.06
0.11

0.00
-0.03
-0.03
-0.03
0.05

Price
Momentum

Profitability

Earnings
Quality

0.00
0.00
0.00
0.00
0.00

1.17
0.70
0.20
-0.47
-1.59

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

Value

Size

Price
Momentum

Profitability

Earnings
Quality

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

1.53
0.42
-0.11
-0.58
-1.27

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

Profitability Pure Quintiles

Profitability

Earnings
Quality

1.40
0.43
-0.01
-0.42
-1.41

-0.15
-0.10
-0.01
0.07
0.18

Q1
2
3
4
Q5

Earnings Quality Naive Quintiles

Price
Momentum

Size

Price Momentum Pure Quintiles

Profitability Naive Quintiles

Price
Momentum

Value

Value

Size

Price
Momentum

Profitability

Earnings
Quality

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

1.40
0.43
-0.01
-0.42
-1.41

0.00
0.00
0.00
0.00
0.00

Earnings Quality Pure Quintiles

Profitability

Earnings
Quality

-0.34
-0.04
0.08
0.17
0.12

1.16
0.55
0.19
-0.29
-1.60

Q1
2
3
4
Q5

Value

Size

Price
Momentum

Profitability

Earnings
Quality

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00

1.16
0.55
0.19
-0.29
-1.60

3) Pure Quintile Portfolios

In each month, for each nave quintile portfolio of each factor (called the target factor) we
run the following optimization to create a corresponding pure quintile portfolio. Here n

is the number of stocks with exposure data to the target factor5, exp the nave quintile
portfolios exposure to the target factor, xi the vector of stock exposures to factor i , w
the vector of weights being optimized, and e a vector of ones. All vectors have size n by
1.
Minimize w' w
Subject to:
w0
e' w 1 ,
xi ' w exp , for the target factor i
for other non-targeted factors i
xi ' w 0 ,
The number of stocks is the same as the nave quintile, i.e. about n / 5

(3.1)
(3.2)
(3.3)
(3.4)
(3.5)
(3.6)

Constraints (3.2) and (3.3) make sure the pure quintile portfolio is long only and 100%
invested. Constraint (3.4) makes its exposure to the target factor the same as the nave
quintile portfolio, and constraint (3.5) makes sure it has zero exposures to other factors.
The right side of Table 1 confirms that these constraints are satisfied. Constraint (3.6)
makes sure it has the same number of stocks as the nave quintile portfolio. This is a
name count constraint and is supported by Axiomas optimizer. Finally, the objective
term (3.1) pushes the optimized weights towards equal weights as much as possible,
which is the weighting scheme of nave quintile portfolios.
It is important to note the similarity and difference between our optimization and those in
previous studies such as Melas et al. (2010) and Grinold and Kahn (2000). In both
situations the exposures to non-targeted factors are set to zero. In previous studies
exposure to the target factor is set to one to create a single long-short portfolio, but here
we vary that exposure to create five portfolios that span the same spectrum of exposures
as nave quintile portfolios. The long only and name count constraints are used to make
them comparable to nave quintile portfolios, but are also needed to avoid the following
situation: the optimizer simply returns a combination of a fixed portfolio with unit
exposure to the target factor and the market for each optimization, and varies their
proportion to get different target factor exposures. Obviously that is not what we intend
to do. Instead we want to find a group of stocks with the same size as a nave quintile
portfolio and weight them, as equally as possible, to satisfy all the desired factor
exposures. It is reasonable to expect a substantial overlap between each nave quintile
portfolio and its pure counterpart because they have the same exposure to the target factor.
On the other hand, the pure quintile portfolio also draws stocks from other nave quintile
portfolios in order to offset other factor exposures. Later we will see that this is indeed
the case.

Note that n is generally different across factors; see Table A1 in the appendix.

Table 2. Performance of Nave and Pure Quintile Portfolios, 1979 2014

Value Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

2.6%
0.4%
-0.8%
-1.2%
-1.1%
3.7%

Value Pure Quintiles

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

8.7%
4.4%
3.1%
4.0%
8.2%
15.7%

0.30
0.10
-0.25
-0.29
-0.14
0.24

153%
248%
255%
220%
130%
282%

Q1
2
3
4
Q5
Q1-Q5

Size Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

2.8%
0.2%
-0.6%
-0.4%
-2.0%
4.8%

9.0%
3.1%
2.8%
3.3%
5.8%
14.1%

0.31
0.06
-0.22
-0.11
-0.35
0.34

195%
225%
185%
135%
69%
265%

Q1
2
3
4
Q5
Q1-Q5

Price Momentum Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

3.7%
0.7%
-0.3%
-1.3%
-2.8%
6.5%

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

10.9%
5.4%
4.3%
4.6%
13.2%
22.3%

0.34
0.13
-0.08
-0.27
-0.21
0.29

328%
604%
664%
606%
335%
664%

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

1.4%
1.0%
0.2%
-0.4%
-2.3%
3.7%

4.7%
4.0%
4.0%
3.5%
9.9%
13.4%

0.31
0.24
0.06
-0.11
-0.23
0.28

103%
150%
173%
168%
132%
235%

Q1
2
3
4
Q5
Q1-Q5

Earnings Quality Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

3.4%
2.5%
1.0%
-1.1%
-5.8%
9.2%

Annual
One-Way
Turnover

3.0%
2.2%
0.0%
-2.0%
-2.7%
5.7%

7.7%
3.9%
2.9%
3.9%
7.2%
12.3%

0.39
0.56
0.01
-0.52
-0.37
0.46

319%
612%
670%
582%
211%
530%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

3.6%
0.4%
-0.5%
-1.2%
-2.2%
5.8%

6.1%
3.7%
2.4%
3.3%
5.0%
10.3%

0.59
0.11
-0.19
-0.38
-0.44
0.56

264%
746%
566%
652%
98%
362%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

4.2%
0.2%
-0.5%
-1.5%
-3.2%
7.4%

10.0%
4.6%
3.3%
4.5%
11.4%
19.4%

0.43
0.04
-0.15
-0.34
-0.28
0.38

398%
736%
865%
818%
378%
776%

Profitability Pure Quintiles

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Returnto-Risk
Ratio

Price Momentum Pure Quintiles

Profitability Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Size Pure Quintiles

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

4.5%
4.3%
3.4%
2.9%
8.1%
11.0%

0.76
0.58
0.28
-0.39
-0.71
0.84

183%
253%
267%
241%
169%
352%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

3.3%
2.2%
-0.7%
-1.5%
-3.0%
6.3%

5.6%
3.7%
3.3%
2.9%
6.7%
9.3%

0.60
0.58
-0.21
-0.52
-0.44
0.68

245%
576%
743%
527%
188%
433%

Earnings Quality Pure Quintiles

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

3.6%
1.4%
0.9%
-1.3%
-5.0%
8.6%

3.3%
3.2%
3.0%
2.6%
5.4%
7.8%

1.09
0.43
0.30
-0.52
-0.92
1.11

208%
610%
619%
606%
202%
411%

Table 2 compares the historical performance of nave and pure quintile portfolios side by
side for the 1979 to 2014 period. The first column shows the average annual returns in
excess of the market for Q1 through Q5, as well as the Q1 minus Q5 return. The second
column shows the annualized risks of these returns measured by standard deviation. The
third column shows the return-to-risk ratio. For Q1 through Q5 it is the Sharpe ratio of
long each quintile and short the market; for Q1-Q5 it is the Sharpe ratio of long-Q1 and
short-Q5. The last column shows annualized one-way turnover. Returns are before
transaction costs and include dividends.
Perhaps the most notable observation from Table 2 is that each factors pure Q1-Q5
portfolio risk is lower by 3% or more than nave Q1-Q5 portfolio, and each pure Q1-Q5
portfolio return is higher by about 1% or more, except for Earnings Quality. As a result,
each pure Q1-Q5 portfolio has substantially higher Sharpe ratio than nave Q1-Q5
portfolio. Looking at Q1 and Q5 separately, we found that almost every pure quintile
portfolio has lower risk than its nave counterpart. This is also true for quintile portfolios
Q2, Q3 and Q4. The higher return of each pure Q1-Q5 portfolio comes from both its long
and short sides. For example, Value pure Q1 return is 40bps higher than Value nave Q1,
and Value pure Q5 return is 1.6% lower than Value nave Q5. The same pattern holds for
other factors (except Earnings Quality Q5). This is evidence that our pure quintile
methodology creates stronger and more stable Q1-Q5 factor returns than nave quintile
sorts.
Annual turnover is high for nave Q1-Q5 portfolios, and even higher for pure Q1-Q5
portfolios. Do higher Sharpe ratios of pure Q1-Q5 portfolios survive after transaction
costs? The answer is yes. Table 3 shows net of transaction costs performance of nave
and pure Q1-Q5 portfolios, assuming 30bps of transaction costs per trade one-way6. For
example, annual transaction costs of nave Value Q1-Q5 is 282%*2*30bps, or about
1.7%, which drags down its return from 3.7% to 2.0%. The turnover of pure Value Q1Q5 is almost twice as high and drags down its return more (from 5.7% to 2.5%) but still
higher than nave Q1-Q5. The net of transaction costs Sharpe ratio of pure Value Q1-Q5
is still handsomely higher than its nave counterpart. The same is true for other factors.
Table 3. Net of Transaction Costs Performance of Nave and Pure Q1-Q5 Portfolios, 1979 2014
Gross of
Net of
Net of
Naive Q1-Q5 Gross of Net of Annualized Net of
Pure Q1-Q5
Annualized
T-Cost
T-Cost
T-Cost
T-Cost
T-Cost
T-Cost
Risk
Risk
Portfolios
Portfolios
Return
Return
IR
Return
Return
IR

Value

3.7%

2.0%

15.7%

0.13

Value

5.7%

2.5%

12.3%

0.21

Size

4.8%

3.2%

14.1%

0.23

Size

5.8%

3.6%

10.3%

0.35

Momentum

6.5%

2.5%

22.3%

0.11

Momentum

7.4%

2.8%

19.4%

0.14

Profitability

3.7%

2.3%

13.4%

0.17

Profitability

6.3%

3.7%

9.3%

0.40

Quality

9.2%

7.1%

11.0%

0.65

Quality

8.6%

6.1%

7.8%

0.79

We think this is a reasonable assumption for US large cap stocks.

Quarterly Rebalance. We can also reduce turnover in both nave and pure quintile
portfolios by rebalancing less frequently than monthly, such as quarterly. To be exact, for
each factor and each quintile (nave or pure) we track 3 portfolios starting from January,
February and March of 1979 respectively. The only change we make is that now each
portfolio is rebalanced quarterly instead of monthly, and returns are calculated by
averaging across the 3 portfolios. Table 4 shows performance of nave and pure quintile
portfolios using quarterly rebalance. Similar to Table 2, here we have the same
observations that pure Q1-Q5 portfolios have much lower risks and higher Sharpe ratios
than nave Q1-Q5 portfolios, and it is still mostly true that pure Q1 portfolios have higher
returns than nave Q1 portfolios; pure Q5 portfolios have lower returns than nave Q5
portfolios; and pure quintile portfolios generally have lower risks than their nave
counterparts.
Comparing turnover numbers in Tables 4 and 2, we see that as expected quarterly
rebalance results in lower turnovers in all cases. The turnover savings are especially big
for Price Momentum, with nave Q1-Q5 annual turnover saving of almost 300% (from
664% to 370%), and pure Q1-Q5 annual turnover saving of 371% (from 776% to 405%).
We also observe that the turnover saving is always bigger for pure quintile and Q1-Q5
portfolios than their nave counterparts, which means quarterly rebalance mitigates
transaction costs more for pure quintile portfolios. Table 5 shows net of transaction costs
performance of nave and pure Q1-Q5 portfolios using quarterly rebalance (again
assuming 30bps of transaction costs per trade one-way). Same results as in Table 3: pure
Q1-Q5 portfolios have substantially higher Sharpe ratios than their nave counterparts
after transaction costs.

10

Table 4. Performance of Nave and Pure Quintile Portfolios, 1979 2014, Quarterly Rebalance

Value Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

1.7%
0.2%
-0.7%
-0.9%
-0.4%
2.1%

Value Pure Quintiles

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

9.8%
4.8%
3.7%
4.7%
9.4%
17.7%

0.18
0.05
-0.18
-0.19
-0.04
0.12

89%
134%
139%
122%
78%
166%

Q1
2
3
4
Q5
Q1-Q5

Size Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

1.9%
0.4%
-0.3%
-0.1%
-1.9%
3.7%

9.4%
3.1%
3.0%
3.4%
6.2%
14.8%

0.20
0.14
-0.09
-0.03
-0.31
0.25

124%
125%
104%
76%
39%
164%

Q1
2
3
4
Q5
Q1-Q5

Price Momentum Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

3.2%
1.0%
0.0%
-1.1%
-3.1%
6.3%

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

11.8%
5.5%
4.4%
5.2%
13.5%
23.2%

0.27
0.18
-0.01
-0.22
-0.23
0.27

180%
265%
278%
267%
190%
370%

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

1.3%
0.8%
0.1%
-0.6%
-1.7%
3.1%

5.1%
4.2%
4.3%
3.8%
10.7%
14.4%

0.26
0.19
0.03
-0.15
-0.16
0.21

76%
115%
134%
130%
100%
176%

Q1
2
3
4
Q5
Q1-Q5

Earnings Quality Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

3.5%
2.2%
0.9%
-1.0%
-5.6%
9.0%

Annual
One-Way
Turnover

1.8%
1.0%
-0.1%
-1.3%
-1.5%
3.3%

7.8%
4.4%
3.1%
4.3%
8.3%
13.8%

0.23
0.23
-0.04
-0.31
-0.19
0.24

156%
245%
259%
237%
116%
273%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

2.7%
0.7%
-0.1%
-0.8%
-2.0%
4.7%

6.6%
3.8%
2.4%
3.6%
5.1%
10.8%

0.41
0.19
-0.04
-0.24
-0.40
0.43

147%
277%
224%
258%
54%
201%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

3.7%
0.8%
-0.3%
-1.2%
-3.6%
7.4%

10.6%
4.3%
3.3%
4.9%
10.7%
19.1%

0.35
0.18
-0.09
-0.24
-0.34
0.38

201%
286%
316%
308%
204%
405%

Profitability Pure Quintiles

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Returnto-Risk
Ratio

Price Momentum Pure Quintiles

Profitability Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Size Pure Quintiles

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

5.0%
4.1%
3.7%
3.0%
8.1%
11.1%

0.70
0.53
0.25
-0.32
-0.69
0.82

148%
209%
221%
196%
135%
283%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

2.2%
1.2%
0.0%
-1.1%
-2.3%
4.4%

6.0%
4.0%
3.4%
3.0%
7.4%
10.4%

0.37
0.30
0.00
-0.37
-0.30
0.43

146%
247%
286%
225%
123%
269%

Earnings Quality Pure Quintiles

Q1
2
3
4
Q5
Q1-Q5

11

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

3.3%
1.6%
0.9%
-1.4%
-4.6%
7.9%

3.4%
3.1%
3.0%
2.8%
5.2%
7.6%

0.98
0.53
0.30
-0.52
-0.88
1.05

155%
275%
284%
268%
144%
299%

Table 5. Net of Transaction Costs Performance of Nave and Pure Q1-Q5 Portfolios, 1979 2014,
Quarterly Rebalance
Naive Q1-Q5
Portfolios

Gross of
T-Cost
Excess
Return

Net of
T-Cost
Excess
Return

Annualized
Risk

Net of
T-Cost
IR

Pure Q1-Q5
Portfolios

Gross of
T-Cost
Excess
Return

Net of
T-Cost
Excess
Return

Annualized
Risk

Net of
T-Cost
IR

Value

2.1%

1.1%

17.7%

0.06

Value

3.3%

1.7%

13.8%

0.12

Size

3.7%

2.8%

14.8%

0.19

Size

4.7%

3.5%

10.8%

0.32

Momentum

6.3%

4.1%

23.2%

0.17

Momentum

7.4%

4.9%

19.1%

0.26

Profitability

3.1%

2.0%

14.4%

0.14

Profitability

4.4%

2.8%

10.4%

0.27

Quality

9.0%

7.3%

11.1%

0.66

Quality

7.9%

6.1%

7.6%

0.81

Pure Quintile Portfolio Distributions. How the stock weights are distributed in
pure quintile portfolios? To answer this question, every month we group each pure and
nave quintile portfolio weights into 100 buckets sorted by each factor and calculate
average bucket weights across all months. Figure 3 shows average weight distributions of
pure and nave Value Q1 and Q5 in buckets sorted by Value, with the lowest Value
exposure in bucket 1 and highest Value exposure in bucket 100. Because the total number
of stocks is a little less than 1000, each bucket contains either 9 or 10 stocks depending
on rounding. By construction, nave Value Q1 weights are evenly distributed among the
top 20 buckets with about 5% in each bucket7. Similarly, nave Value Q5 weights are
evenly distributed among the bottom 20 buckets. On the other hand, pure Value Q1 and
Q5 have wider distributions than the nave quintiles. For example, while the majority of
pure Value Q1 weights are from the top 20 buckets, it also has a long tail of distributions
in other buckets in order to neutralize other factor exposures. It also has more weights
than nave Q1 in the top 10 or so buckets in order to offset lower Value exposures from
the long left tail and match the Value exposure of nave Q1. Pure Value Q5 has a similar
story.
Figure 4 shows these same portfolios in buckets sorted by Momentum, with bucket 1
having the lowest Momentum exposure and bucket 100 having the highest Momentum
exposure. Because of the negative correlation between nave Value and Momentum, the
distributions of nave Value Q1 are skewed towards low Momentum buckets, and nave
Value Q5 are skewed towards high Momentum buckets. The Pure Value Q1 and Q5
distributions are flat around 1% (i.e. average bucket weight) because they are constructed
to have zero exposures to Momentum.

It is not exactly 5% in each bucket because of rounding.

12

Figure 3.

Figure 4.

13

Figure 5.

Similar observations hold for pure and nave quintiles Q2, Q3 and Q4. Figure 5 shows
their distributions in Value buckets. By definition each nave quintile portfolio spans a
continuous block of 20 buckets with 5% in each bucket. Each pure quintile portfolio
distribution centers on the buckets of its nave counterpart, but is wider in order to
include more stocks to neutralize other factor exposures. We are not showing their
distributions in Momentum buckets as they are all close to the 1% line, but pure Q2 and
Q4 are still flatter than nave Q2 and Q4, while pure Q3 and nave Q3 are on top of each
other.

4) International Developed and Emerging Market Universe

Do the same findings exist in non-US stocks? To answer that we repeat the analysis using
Developed International and Emerging Market stocks. In the former case we use stocks in
the MSCI World ex. USA index from January 1995 to December 2014; in the latter case
we use stocks in the MSCI Emerging Market index from January 1999 to December 2014.
These time periods are chosen so that a majority of the stocks in the universe has data on
each factor (especially Earnings Quality). Raw data is sourced from WorldScope and
MSCI and processed in AllianceBernsteins internal equity research database. To remove
currency related effects we use USD hedged returns to measure performance.
Similar to Table 2, Tables 6 and 7 show historical performance of nave and pure quintile
portfolios using Developed International and Emerging Market stocks. We observe that
in both tables pure Q1-Q5 portfolios still have lower risks than nave Q1-Q5 portfolios,
although the differences are smaller than in the US: they range from 1% for Price
Momentum to 2.7% for Size in Emerging Markets. Unlike in the US, in Developed
International and Emerging Markets pure Size Q1-Q5 portfolios have lower returns and
14

Sharpe ratios than nave Size Q1-Q5 portfolios. On the other hand, for Value, Price
Momentum and Profitability the return enhancements from nave to pure Q1-Q5 are
substantially stronger than in the US. For example, while pure Value Q1-Q5 return is 2%
higher than nave Q1-Q5 return in the US (Table 2), it is 5.3% higher in Developed
International market and 9.2% higher in Emerging Market. As we have demonstrated
with US data, these higher returns survive the higher transaction costs. For these three
factors it is also true that pure Q1 return is higher than nave Q1, and pure Q5 return is
lower than nave Q5.
We conclude that, though not as consistent as in the US, overall there are still notable
evidences in Developed International and Emerging Markets that pure Q1-Q5 portfolios
represent purer, stronger and more stable factor returns than nave Q1-Q5 portfolios.

15

Table 6. Performance of Nave and Pure Quintile Portfolios, 1995 2014, International Developed
Stocks

Value Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

3.9%
0.7%
-1.3%
-2.0%
-1.2%
5.1%

Value Pure Quintiles

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

8.4%
3.6%
2.8%
3.6%
7.0%
14.4%

0.47
0.21
-0.48
-0.57
-0.17
0.35

156%
261%
265%
212%
115%
271%

Q1
2
3
4
Q5
Q1-Q5

Size Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

1.4%
-0.1%
-0.4%
-0.5%
-0.4%
1.8%

Q1
2
3
4
Q5
Q1-Q5

2.3%
1.4%
0.7%
-0.8%
-3.6%
5.8%

Annualized
Risk

Annual
One-Way
Turnover

6.0%
3.1%
2.5%
2.5%
4.8%
9.9%

0.23
-0.03
-0.17
-0.20
-0.09
0.18

128%
178%
166%
127%
67%
195%

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

8.4%
4.8%
3.4%
3.7%
11.7%
19.1%

0.27
0.29
0.20
-0.21
-0.30
0.30

324%
612%
665%
606%
324%
648%

Q1
2
3
4
Q5
Q1-Q5

Annual
One-Way
Turnover

6.4%
2.1%
-0.8%
-2.9%
-3.9%
10.4%

8.6%
3.4%
2.7%
3.6%
7.1%
12.8%

0.75
0.60
-0.32
-0.80
-0.56
0.81

323%
590%
665%
491%
195%
518%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

0.4%
0.4%
0.4%
0.0%
0.0%
0.4%

4.7%
3.6%
3.4%
2.8%
4.6%
7.8%

0.09
0.12
0.13
-0.01
-0.01
0.06

156%
663%
681%
640%
99%
255%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

2.9%
2.1%
0.7%
-1.9%
-4.1%
6.9%

7.9%
4.4%
2.8%
3.8%
10.9%
17.6%

0.36
0.48
0.23
-0.49
-0.37
0.39

385%
780%
895%
825%
383%
767%

Profitability Pure Quintiles

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

1.9%
1.8%
0.6%
-1.5%
-2.6%
4.5%

5.4%
4.3%
3.0%
4.2%
7.7%
12.3%

0.35
0.41
0.19
-0.35
-0.34
0.37

93%
140%
157%
151%
120%
213%

Q1
2
3
4
Q5
Q1-Q5

Earnings Quality Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Returnto-Risk
Ratio

Price Momentum Pure Quintiles

Profitability Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Size Pure Quintiles

Returnto-Risk
Ratio

Price Momentum Naive Quintiles

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

1.6%
1.4%
0.2%
-0.3%
-2.9%
4.5%

3.6%
3.5%
3.1%
2.6%
5.4%
7.5%

0.43
0.39
0.08
-0.11
-0.54
0.60

134%
149%
156%
149%
127%
261%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

4.5%
2.4%
-1.2%
-2.2%
-5.0%
9.6%

6.7%
3.2%
4.0%
4.0%
5.5%
10.6%

0.68
0.76
-0.29
-0.55
-0.92
0.90

240%
611%
765%
602%
179%
419%

Earnings Quality Pure Quintiles

Q1
2
3
4
Q5
Q1-Q5

16

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

1.4%
1.2%
1.4%
-0.5%
-3.1%
4.5%

3.1%
3.1%
2.6%
2.2%
4.4%
5.9%

0.46
0.38
0.52
-0.24
-0.69
0.76

159%
634%
530%
566%
164%
323%

Table 7. Performance of Nave and Pure Quintile Portfolios, 1999 2014, Emerging Market Stocks

Value Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

5.9%
1.9%
-1.4%
-2.5%
-3.7%
9.6%

Value Pure Quintiles

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

10.1%
4.2%
3.0%
4.9%
7.9%
16.9%

0.59
0.46
-0.48
-0.52
-0.46
0.57

175%
286%
299%
251%
140%
316%

Q1
2
3
4
Q5
Q1-Q5

Size Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

1.9%
0.5%
0.1%
-0.2%
-1.8%
3.7%

Annualized
Risk

Annual
One-Way
Turnover

10.9%
3.8%
3.7%
4.4%
5.3%
15.0%

0.17
0.12
0.02
-0.04
-0.33
0.24

155%
229%
218%
172%
93%
248%

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

5.2%
1.6%
-0.3%
-3.2%
-3.2%
8.4%

9.2%
5.9%
4.8%
4.5%
12.5%
19.5%

0.56
0.26
-0.07
-0.71
-0.26
0.43

319%
601%
661%
610%
340%
659%

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

1.9%
0.2%
1.0%
0.4%
-3.4%
5.3%

6.0%
4.1%
4.0%
3.1%
9.3%
14.0%

0.32
0.05
0.24
0.12
-0.37
0.38

119%
175%
189%
180%
140%
259%

Q1
2
3
4
Q5
Q1-Q5

Earnings Quality Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

0.3%
1.5%
1.4%
-0.5%
-2.6%
2.8%

Annual
One-Way
Turnover

9.6%
1.3%
-1.7%
-4.5%
-9.2%
18.8%

8.5%
4.2%
4.2%
5.6%
9.4%
14.7%

1.14
0.32
-0.41
-0.80
-0.98
1.27

287%
685%
714%
551%
231%
518%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

0.9%
-0.6%
-1.1%
1.2%
-0.3%
1.2%

9.0%
4.7%
3.3%
4.3%
5.3%
12.3%

0.11
-0.13
-0.33
0.28
-0.05
0.10

187%
554%
579%
716%
98%
286%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

6.6%
1.7%
-1.2%
-3.9%
-6.9%
13.5%

9.3%
5.0%
4.1%
5.0%
11.4%
18.5%

0.71
0.33
-0.29
-0.79
-0.60
0.73

356%
812%
824%
780%
396%
752%

Profitability Pure Quintiles

Avg. Annual
Excess
Return

Avg. Annual
Excess
Return

Returnto-Risk
Ratio

Price Momentum Pure Quintiles

Profitability Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Annualized
Risk

Size Pure Quintiles

Returnto-Risk
Ratio

Price Momentum Naive Quintiles

Q1
2
3
4
Q5
Q1-Q5

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

5.2%
3.9%
3.4%
3.5%
6.3%
10.0%

0.05
0.38
0.41
-0.15
-0.41
0.28

140%
154%
162%
159%
142%
281%

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

2.9%
2.9%
1.6%
-1.8%
-7.1%
10.0%

7.2%
4.7%
4.2%
3.8%
7.9%
12.0%

0.40
0.62
0.38
-0.46
-0.90
0.83

236%
601%
694%
565%
182%
418%

Earnings Quality Pure Quintiles

Q1
2
3
4
Q5
Q1-Q5

17

Avg. Annual
Excess
Return

Annualized
Risk

Returnto-Risk
Ratio

Annual
One-Way
Turnover

0.0%
-0.3%
0.7%
-0.8%
-2.3%
2.3%

4.0%
4.3%
3.2%
4.0%
5.7%
8.4%

0.00
-0.07
0.21
-0.19
-0.41
0.28

164%
709%
571%
660%
178%
342%

5) Concluding Remarks
Over the last few decades many factors have been identified as being predictive of the
cross-section of stock returns. When a new factor is reported, a typical way of assessing
its predictive power is sorting by the factor to create a number of portfolios (such as
quintiles or deciles) with increasing factor scores and examine their performance.
However, sorting does not control the impact of other factors and often leads to
significant other exposures. Therefore it does not help us understand the efficacies of
pure exposures to the factor in question. Existing techniques to disentangle among factors
either does not generalize to multiple factors (e.g. two-way sorts), or only reveals
information on one point of the spectrum of pure exposures (e.g. Factor-Mimicking
Portfolios). We are not aware of any other method that solves both problems. In this
paper we extend and adapt the optimizations used to create Factor-Mimicking Portfolios,
and then use them to create pure quintile portfolios that disentangle among multiple
factors and reveal the cross-sectional efficiencies of pure factor exposures.
By construction, each pure quintile portfolio has the same number of stocks and exposure
to the target factor as its nave counterpart, and therefore there is a big overlap between
their stock distributions. On the other hand, the pure quintile portfolio has a wider
distribution in order to include stocks outside of the nave quintile to neutralize exposures
to other factors. By comparing the performance of pure and nave quintile portfolios, we
found strong evidence in US large cap stocks that pure quintile and Q1-Q5 portfolios
have lower risks, and pure Q1-Q5 portfolios have higher returns and Sharpe ratios.
Similar but weaker evidences exist in Developed International and Emerging Market
stocks. We also note that pure quintile portfolios have higher turnovers than nave
quintile portfolios and therefore higher transaction costs when being implemented, but
their net of transaction costs Sharpe ratios are still comfortably higher. This should come
as good news when we explore their practical applications.

18

References
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19

Appendix
Table A1. Number of Stocks by Year and Factor, Russell 1000 Universe
Price
R1000
Value
Size
Profitability
Momentum

1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

955
948
946
955
956
952
987
985
985
996
993
976
986
988
998
990
981
982
983
970
956
970
956
969
989
989
988
979
984
969
954
933
948
955
965
975

900
894
903
909
917
914
936
937
941
948
955
937
962
962
973
964
956
957
958
950
933
958
948
963
981
981
952
977
982
965
950
932
946
955
965
973

955
948
946
955
956
952
987
985
985
996
993
976
986
988
998
990
981
982
983
970
956
970
956
969
989
989
988
979
984
969
954
933
948
955
965
975

900
892
903
913
923
919
942
946
948
950
954
931
956
962
970
956
948
952
954
951
929
953
940
957
977
979
954
974
973
965
950
933
948
932
939
950

20

946
943
927
936
944
923
966
970
956
976
976
967
969
975
983
976
963
964
954
950
932
927
926
950
974
985
968
961
957
947
936
927
936
934
948
950

Earnings
Quality

All

839
837
841
839
865
907
931
933
929
934
942
932
953
961
968
957
952
954
948
957
936
954
948
963
982
981
955
974
979
963
949
932
946
951
962
969

832
833
830
830
853
887
919
920
906
918
926
914
927
943
945
932
928
931
925
924
900
908
911
935
965
973
947
957
953
946
934
926
934
913
923
926