The expected return of a financial asset can be modeled as a function of various theoretical factors according to three main categories: macroeconomic, statistical, and fundamental. Employing multiple factors addresses their cyclicality and increases diversification. However, there is no free lunch attached to factor investing.
The asset selection decision can be an active one, where the investor attempts to buy undervalued assets in each asset class (or sell overvalued ones) or a passive one, where the investor invests across assets in an asset class, without attempting to make judgments on under or over valuation
Capital allocation methods are used to estimate risk margins in the form of return on equity (ROE) measurements and targets from a top-down perspective. Actuarial risk theory views risk from a bottom-up perspective because it aims at modeling solvency. At a macro level, financial theory views capital as the equity capital supplied by investors.
