A factor is any characteristic that helps explain the long-term risk and return performance of an asset class. Factors are well documented in academic research and have been used extensively in portfolio risk models and in quantitative investment strategies. These are the same variables that active fund managers have used in their security selection and portfolio construction process.
Factor investing is not new; it has long been used in quantitative investment strategies. Factor investing seeks to capture higher risk adjusted returns via systematic exposure to stock characteristics. Over the years, both the academic world and the investment industry have identified 6 individual factors that have historically delivered out-performance relative to the broad stock market.
These six factors are:
Value – Investing in relatively inexpensive stocks
Momentum – Investing in stocks with positive price movement
Quality – Investing in quality companies with sound balance sheets
Smaller Size Companies – Investing in small and mid-sized companies
Dividend Yield – Investing in companies with above average cash flow payout
Low Volatility Stocks – Investing in lower beta stocks
Below is detailed information on these six factors. In constructing individual portfolios for clients, we strive to capture at least three of these factors.