Investing Ideas

The power of factor investing

An overview of the growing trend of factor investing

By: Bobby Barnes Darby Nielson Frank Nielsen
Updated: 12/1/2023
Key Takeaways
  • Factors such as size, value, momentum, quality, dividend yield, and low volatility are at the core of "smart" or "strategic" beta strategies, and are investment characteristics that have tended to enhance portfolios over time.
  • Factor performance tends to be cyclical, and factor returns have generally not been highly correlated with one another historically, so investors have benefited from diversification by combining multiple factor strategies.
  • Factor-based strategies may help investors meet certain investment objectives—such as potentially improving returns or reducing risk over the long term.
     

In the world of asset management, there is a growing trend towards a systematic approach to factor investing. But what exactly is factor investing?

In this article, we will offer an overview of factor investing and invite you to explore our white paper that delves into the merits of factors as potential building blocks for portfolio construction.

What is factor investing?

Factor investing is a key component of investment process and philosophy. Factors are characteristics of securities that can help explain risk and return. There are 6 widely adopted factors identified by investors; size, value, momentum, quality, dividend yield and low volatility.

Multiple factors are components of stock returns and risk

Why factor investing?

Factor investing has received considerable attention recently, primarily because factors are the cornerstones of smart or strategic beta strategies that have become popular among individual and institutional investors. In fact, these strategies had amassed more than $1.8 trillion in assets through the end of 2022.1 But investors have been employing factor-based techniques in some form for decades, seeking the potential enhanced risk-adjusted-return benefits of certain factor exposures.

The role of quantitative actively managed funds

Factor-based investments are founded on the systematic analysis, selection, weighting, and rebalancing of portfolios, in favor of stocks with certain characteristics that have been proven to enhance risk-adjusted returns over time. Most commonly, investors gain exposure to factors using quantitative, actively managed funds, or rules-based ETFs designed to track custom indexes.

Gaining factor exposure in portfolio construction

Factor-based investment strategies can provide investors with targeted and streamlined access to factor exposures. It is important to note that the factor- investing universe is broad and extends beyond single-factor strategies targeting the six key factors addressed in this article. Many factor-based strategies provide exposure to multiple factors within one vehicle.

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An overview of factor investing
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Endnotes

1.Includes in smart (or strategic) beta strategies, across all US Domiciled ETFs and Mutual Funds (as categorized by Morningstar). Source: Morningstar, as of 12/31/22.

​Diversification does not ensure a profit or guarantee against a loss.
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