- The report proposes an iterative factor selection strategy to compress the "factor zoo" by systematically evaluating the contribution of new factors to the remaining alpha of the factors using the GRS statistic[2][3][4] - The iterative factor selection process starts with the CAPM model and adds one factor at a time that maximally reduces the remaining alpha of the factors, measured by the decrease in the GRS statistic[3][25][26] - The process stops when the added factor no longer makes the remaining alpha of the factors statistically significant from zero[3][25][26] - The study finds that only 10 to 20 carefully selected factors are needed to effectively explain the performance of 153 factors in the US market, indicating high redundancy among factors[4][17][19] - The selected factors come from 8 out of 13 factor style categories, showing the heterogeneity of the factor set[17][19] - The iterative factor model outperforms common academic models by selecting alternative definitions of value, profitability, investment, or momentum factors, or including alternative factor style categories such as seasonality or short-term reversal[17][19] - The study also confirms that equal-weighted factors exhibit stronger and more diverse alpha, requiring more than 30 factors to cover the factor zoo[4][64][69] - The effectiveness of the method is validated using global data, showing similar core factor sets across different regions, but with the global model explaining US factors better than non-US factors[4][71][75] - The iterative factor selection strategy provides a practical framework for investors to streamline their models by focusing on the most relevant factors[2][3][4] Factor Selection Process Results - The iterative factor selection process results in a model that starts with the CAPM model, which leaves 105 significant alphas (t>2) and 86 significant alphas (t>3) with a GRS statistic of 4.36 and a p-value of 0.00[39][40] - Adding the cash-based operating profits-to-book assets (cop_at) factor reduces the GRS statistic to 3.54, leaving 101 significant alphas (t>2) and 78 significant alphas (t>3) with an average absolute alpha of 3.94%[39][40] - The process continues by adding factors such as change in net operating assets (noa_grla), sales growth (saleq_gr1), and intrinsic value-to-market (ival_me), among others, until the remaining significant alphas are reduced to zero[39][40][41] - The final model includes 15 to 18 factors, depending on the significance threshold, effectively explaining the factor zoo[39][42][43] Comparison with Common Academic Models - The iterative factor model leaves fewer significant alphas compared to common academic models such as the Fama and French five-factor and six-factor models, the q-factor model, and the mispricing model[43][44] - The Barillas et al. (2020) revised six-factor model performs better than other academic models but still leaves 33 significant alphas, while the iterative factor model leaves only 10 significant alphas with four factors and 14 significant alphas with five factors[43][44] Global Factor Analysis - The global factor analysis shows that 11 global factors are needed to cover the global factor zoo at the t>3 threshold, and around 20 factors at the t>2 threshold[73][74] - The global factor model explains US factors better than non-US factors, indicating that international factors have higher and more diverse alpha potential[75][76][77] Rolling Window Analysis - The rolling window analysis shows that the number of factors needed to cover the factor zoo decreases over time, with around 8 factors needed in recent years compared to 15 factors in the early sample period[59][60][61] - The most relevant factor styles over time include low volatility, seasonality, investment, and quality, while the relevance of momentum, short-term reversal, and value has decreased in recent years[59][60][61] Robustness to Alternative Weighting Schemes - The robustness analysis shows that equal-weighted factors require more than 30 factors to cover the factor zoo, while cap-weighted and value-weighted factors require 18 and 19 factors, respectively[64][65][69] - The equal-weighted factor model exhibits higher and more diverse alpha potential, indicating the need for more factors to cover the equal-weighted factor zoo[64][65][69]