The Essentials of Factor Investing

You’ve probably heard of factor investing. But what does it mean exactly and how widespread has this investment approach become?

Learning objectives

• The basic principles behind factor investing

• When its foundations were laid

• That factor investing has rapidly gained popularity among investors

Factor investing can be viewed as a third way of investing next to traditional fundamental active and passive strategies.

Learning objectives

• How factor investing fits between active and passive

• Why it is a proven concept

• Why so many investors have embraced it

Factor investing is based on thorough academic research, with over four decades of empirical research showing it to be a robust investment concept. This chapter explains:

Learning objectives

• How factor premiums were discovered

• Which were the most important milestones for factor investing

• How current research goes well beyond equities and bonds
  

Over the years, dozens of purported factors have been identified by researchers. But are all the anomalies included in the ‘factor zoo’ worthy of consideration?

Learning objectives

• The criteria a proven factor should meet

• Which factors are the most broadly accepted

• The basic definitions of common factors

Factor investing can help pursue two main investment goals: reduce risk and enhance returns. But how does that work in practice?

Learning objectives

• The historical performance of proven factors

• How factors can help achieve higher long-term returns

• The basics of low-risk investing
  
  

Factor investing can also help achieve very specific purposes, such as those most frequently cited in the latest annual survey of asset owners by FTSE Russell (see Figure 8).

Learning objectives

• Some of the objectives leading investors to consider factor investing

• The mechanics at work behind each objective

• That different goals can be pursued simultaneously
  
  

Not all products, labelled as factor strategies lead to the best investment outcomes. In particular, generic products can prove disappointing over time.

Learning objectives

• Why generic factor investing products may not be the best option

• How enhanced strategies address the pitfalls of generic products

• That asset-specific challenges must also be considered

Over the past decade, the financial industry has seen a structural shift as investors allocated funds from actively managed fundamental strategies to passive vehicles and factor investing strategies. How can investors benefit from factor premiums?

Learning objectives

• Why factor investing has been embraced

• How factor investing can be implemented

• Where to start when evaluating factor investing strategies

In this final chapter, we summarize the main points: