Can competition increase profits in factor investing?

De-Miguel Campos, V, Martin-Utrera, A and Uppal, R (2024) Can competition increase profits in factor investing? Management Science. ISSN 0025-1909 (In Press)

Abstract

The increasing number of institutions exploiting factor-investing strategies raises concerns that competition may erode profits. We use a game-theoretic model to show that, while competition among investors exploiting a particular factor erodes profits because of the negative externality of their price impact on each other, competition to exploit other factors can increase profits from the first factor because of the positive externality from trading diversification (netting of trades across factors). We calibrate our model using the investment and profitability factors and find that competition to
exploit the profitability factor leads to a 68% increase in the capacity and a 143% increase in the profit from the investment factor.

Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.02684