Factor investing is an investment approach that involves targeting specific drivers of return across asset classes [1]. It is a strategy that selects securities based on attributes that are associated with higher returns [2]. There are two main types of factors in factor investing:
1. Macroeconomic Factors: These factors capture broad risks across asset classes. They include factors such as economic growth, inflation, interest rates, and market sentiment [2].
2. Style Factors: Style factors aim to explain returns and risks within asset classes. They include factors such as value, quality, momentum, size, and minimum volatility [2][3]. Learn more about style factors and criteria of varied factors here.
Factors are persistent and well-documented characteristics that can help investors understand differences in expected return [3]. They have an economic rationale for why they have existed historically and why they are expected to persist in the future [3].
Factor investing can be implemented through various investment vehicles, including factor-based funds and exchange-traded funds (ETFs) [4][5]. These funds purposely tilt portfolios towards certain stock characteristics to achieve specific risk and return objectives [4]. However, it's important to note that factor investing comes with higher risk compared to investing in the broader stock market [4].
Some factors are not highly correlated with each other, and different factors may perform well at different times [6]. Factor returns tend to be cyclical, and no single factor works well all the time [6]. Learn more about how different factors perform at different stages in the business cycle and correlation between style factors by clicking here. But aside from improved performance, factor investing has further advantages. You can get a comprehensive review of the benefits of factor investing here.
In summary, factor investing is an investment strategy that targets specific drivers of return across asset classes by selecting securities based on attributes associated with higher returns. It utilizes macroeconomic and style factors to analyze and explain asset prices and build an investment strategy.
Additional considerations about factor investing you will find here.
Disclaimer: The scenarios or investment products presented above should not be construed as investment advice. All investments involve some level of risk, and past performance is never a guarantee of future returns. As always, do your own research in order to validate and better understand the underlying risks.
Citations:
[1] https://www.blackrock.com/us/individual/investment-ideas/what-is-factor-investing
[2] https://www.investopedia.com/terms/f/factor-investing.asp
[3] https://www.ishares.com/us/insights/what-is-factor-investing
[4] https://investor.vanguard.com/investor-resources-education/understanding-investment-types/what-are-factor-based-funds
[5] https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/fidelity/fidelity-overview-of-factor-investing.pdf
[6] https://www.fidelity.com/learning-center/investment-products/etf/factor-based-investing
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