Factor Investing

Factor investing overweights assets with characteristics that historically beat the market. A strategy between passive and active management. Track your portfolio in Index Balance.

Definition

Factor investing is a strategy that overweights assets with certain characteristics known as "factors" that have historically generated returns above the market in a persistent way. The most documented factors are: value, size (small cap), momentum, quality, and low volatility.

Unlike traditional active management that selects individual securities, factor investing follows systematic and transparent rules: for example, a "value" factor fund buys all companies with a low price-to-earnings ratio. It is a semi-passive form of management that sits between pure index funds and discretionary active funds.

There is academic and practical debate about whether factors will continue to work now that they are widely known. Evidence shows there are long periods of factor underperformance (such as value between 2008-2020) that can make it difficult to maintain discipline. For most individual investors, the simplicity of an MSCI World fund is preferable to the complexity of factor investing.

Practical example

The iShares MSCI World Value Factor ETF overweights companies with low valuations (low P/E ratio, low P/B ratio). Between 1975 and 2022, the value factor outperformed the MSCI World by approximately 1.5% annually. However, between 2007 and 2020 it recorded cumulative underperformance of more than 40% relative to the broad index. An investor in that factor needed 13 years of patience.