Methodology and Process For Constructing Factor Indexes

Abstract

Approaches to the construction of indexes are addressed wherein a portfolio of securities such as stocks, bonds, or the like and their associated investment weights or shares is generated. Indexes can be used as investment tools in various ways. For instance, indexes comprising a plurality of securities can often be bought and sold more cheaply than buying and selling the individual constituents of the index. This pricing differential allows investment with reduced transaction costs. Alternatively, in passive and enhanced indexing, investments are made with reference to an index. Performance statistics such as return and risk are reported with respect to the reference index. Factor indexes can serve as active manager benchmarks or the underlyers for investable products such as exchange traded funds and mutual funds. Computer based systems, methods and software are addressed for constructing indexes that replicate the returns of a quantitative factor such as medium term momentum or value. Further, processes and methodology are described by which the index can have the best possible replication of the underlying factor returns as well as other desirable characteristics. The methodology provides an approach to determine the index even when all desirable characteristics of the index are not simultaneously achievable.

Description

[0001]The present application is a divisional of U.S. application Ser. No. 12 / 958,778 filed Dec. 2, 2010 and claims the benefit of U.S. Provisional Patent Application Ser. No. 61 / 265,910 filed Dec. 2, 2009, which are incorporated by reference herein in their entirety.FIELD OF INVENTION[0002]The present invention generally relates to the construction of indexes wherein a portfolio of securities such as stocks, bonds, or the like and their associated investment weights, allocations, or shares are determined. The present invention relates more particularly to improved computer based systems, methods, and software for constructing factor indexes that replicate the returns associated with a quantitative factor such as medium term momentum or value.BACKGROUND OF THE INVENTION[0003]Indexes can be used as investment tools in various ways. For instance, indexes comprising a plurality of securities can often be bought and sold more cheaply than buying and selling the individual constituents o...

AI Technical Summary

Benefits of technology

The invention described herein overcomes shortcomings with current factor index construction methodologies. It allows for the creation of indexes that have practical applications such as low turnover, controlled transaction costs, and limited number of names held, while also being neutral to non-target factors. The invention achieves a beneficial tradeoff between these competing portfolio characteristics. It also introduces improved computer systems and methods for constructing indexes that replicate the returns of a quantitative factor such as momentum or value, as well as those that target multiple factors simultaneously. The approach takes into account the factors' characteristics, risks, and investment opportunities to create indexes that are efficient and effective. The patent text describes the construction methodology for a particular factor, considered as an example and not a limitation.

Problems solved by technology

During times of high volatility, it is often impossible to track factor returns well and simultaneously manage index turnover and maintain factor neutrality to other factors.

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