Factor Investing is one of the latest buzzwords in the investment sector, which is still to make a considerable presence on Indian soils. Investments have been traditionally done generally based on various Asset-Classes. This traditional knowledge took a setback when the global financial crisis grouped many unrelated stock together thus raising critical doubts over the synchronisation of the till then diversified portfolios. Many investors were perplexed over the similar performance of varied stocks. It was factor-based investing which provided answers to the muddled investors and brokers. In factor-investing, all the underlying factors are studied which ultimately determine risk, return and hence correlation between widely different assets and differences between the related ones.
What is Factor Investing?
Factor investing is a more sophisticated and an innovative way to look at the same investments but through a different lens. The investors instead of just going after sectors or asset classes pick and build portfolios that are similarly affected under a given set of economic, political, geopolitical conditions. Thus, investors consider increased level of granularity when choosing different securities. They may be widely spread over the spectrum of asset classes but move in the same direction under a particular set of conditions. The most commonly used factors are style, size and risk of a security.
Commonly considered factors
A factor can be defined as any change in conditions like economic or political which have similar affect on a line of securities irrespective of their sector. People who are experienced in stocks have concluded that long-run, equity stocks in which risk has been already factored-in are more likely to have common factors. In such cases the factors which are considered like volatility, dividend yield, etc. The factors are thus nothing but a deeper look at the drivers of risk and return. These link the completely uncorrelated asset classes. The DINO concept-diversification in name only, has gained prominence as many turbulent times in economic history have pointed towards the fact that hitherto considered correlated assets changed significantly under geopolitical, inflationary, recessionary trends. The factors thus can be grouped under different labels- macroeconomic basket which contains national GDP, inflation, interest rates etc.; regional basket which contains currency, emerging market scenario, international exposure; etc.
Advantages of Factor Investing
actor investing is catching up as a popular measure to ride the uncertainties in global markets. Building a diverse portfolio loses sense if all the stocks react similarly to a market situation and lead to cyclical returns with long spells of depressed or elevated periods. Factor investing thus works to minimise risk by studying unique criteria in depth and adjust the portfolio to minimise risk. Thus, one has to balance between the traditional wisdom and new-age sensibilities as it can lead to long-term returns.
Exchange-traded funds by Index providers like MSCI Inc. are an easy way to invest using factor-investing as the latter have built specific factor indices in which stocks are weighted according to a common factor.