The Comparative Advantages of Factor Diversification versus Holding Diversification in Actively Managed High-Yield Bond Portfolios

This article examines the comparative impacts of factor diversification and holding diversification on high-yield bond portfolio performance. Traditional portfolio construction methods typically focus on reducing idiosyncratic risk by increasing the number of individual holdings. The rise of multifactor investing in corporate bonds introduces new dimensions to risk management. Using empirical analysis, this study assesses how allocation across multiple active return sources—carry, value, momentum, quality, low volatility, and size—interacts with conventional holding-diversification strategies. The research also considers these diversification methods beyond a friction-free environment and incorporates practical constraints such as transaction costs and limited portfolio turnover. Results indicate that after considering market frictions, factor diversification still offers significant risk mitigation advantages, equal to or greater than those provided by expanding the number of holdings. More importantly, for high-yield active managers aiming to outperform their benchmark, factor diversification preserves factors’ predictive powers and delivers attractive risk-adjusted returns. This study provides practical guidance for portfolio managers on diversifying high-yield bond portfolios utilizing both the range of holdings and factor exposures.