Factor Investing
Factor investing is a strategy that chooses securities on attributes that are associated with higher returns. There are two main types of factors that have driven returns of stocks, bonds, and other factors: macroeconomic factors and style factors. The former captures broad risks across asset classes while the latter aims to explain returns and risks within asset classes.Some common macroeconomic factors include: the rate of inflation; GDP growth; and the unemployment rate. Microeconomic factors include: a company's credit; its share liquidity; and stock price volatility. Style factors encompass growth versus value stocks; market capitalization; and industry sector.
Factor Investing
Definition
Factor investing is a strategy that selects securities with high return attributes by identifying and utilizing specific factors that influence the returns of stocks, bonds, and other assets.
Origin
The concept of factor investing dates back to the 1970s when financial scholars began studying different factors affecting asset returns. Early research includes the Fama-French three-factor model, which identified market risk, company size, and value factors as influential on stock returns.
Categories and Characteristics
Factor investing is mainly divided into two categories: macroeconomic factors and style factors.
- Macroeconomic Factors: These factors cover broad risks across asset classes, including inflation rate, gross domestic product (GDP) growth rate, and unemployment rate.
- Style Factors: These factors aim to explain returns and risks within asset classes, including growth vs. value stocks, market capitalization, and industry sectors.
Specific Cases
Case 1: An investor analyzes macroeconomic factors such as inflation rate and GDP growth rate to select stocks that perform well during economic growth periods. This strategy helps them achieve excess returns during economic expansions.
Case 2: Another investor focuses on style factors, selecting stocks of small-cap companies with high growth potential. Through this strategy, they achieve higher returns during market fluctuations.
Common Questions
- Is factor investing suitable for all investors? Factor investing requires a certain level of expertise and data analysis skills, making it unsuitable for all investors, especially beginners.
- What are the risks of factor investing? While factor investing can yield high returns, it also comes with high risks. Investors need to be cautious in selecting and managing their investments.
