Any index fund whether it is broad based or sectoral or strategic is rebalanced quarterly or semiannually., resulting in higher turn over, compared to typical long and hold value based portfolio. We have to incur the brokerage, direct-indirect taxes, PnL caused due to rebalancing. This also results in tracking error. It is the cost of doing business. We have to accept it.
However in case of multi factor portfolio there is a possibility that a stock which is to be sold from one portfolio may be shortlisted in another, that will reduce turnover and associated costs.
For e.g if stock ABC is in momentum portfolio and let’s say in next three months it goes through correction, it might result in attractive valuation ratios. We may be need to sell it from momentum portfolio and purchased in value portfolio, so no action will be required.
The backtested returns of factor based portfolios do not consider these costs. We have to take into consideration its effect on the long term returns.
Even if we consider the 0.5 to 1% tracking error, The CAGR of these factor based portfolios/ indices will most proabaly be higher than many active mutual funds and broad based indices. Turn over is less likely to affect compounding and wealth creation.
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