Explain how risk factors are used in asset allocation and how they relate to allocation by asset class

Asset classes are bundles of underlying risk factors: a corporate bond carries interest rate duration and credit spread exposure; equities carry growth, inflation and liquidity exposure. Allocating by factor means choosing exposures directly, such as inflation, real rates, economic growth, credit, duration, size, value, momentum, liquidity and volatility, usually expressed as long–short, zero-investment portfolios. The advantage is visibility: two asset classes that look distinct may share the same factor, hiding concentration. The drawbacks are the need for shorting, leverage and more complex implementation, and results that are harder to explain to a board. The two approaches can reach similar efficient portfolios; the factor lens is often used to analyse a class-based allocation.