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.

Understanding Factor Investing

Factor investing, from a theoretical standpoint, is designed to enhance diversification, generate above-market returns and manage risk. Portfolio diversification has long been a popular safety tactic, but the gains of diversification are lost if the chosen securities move in lockstep with the broader market. For example, an investor may choose a mixture of stocks and bonds that all decline in value when certain market conditions arise. The good news is factor investing can offset potential risks by targeting broad, persistent, and long recognized drivers of returns.

Factor investing can seem overwhelming given the number of factors to choose from. Rather than look at complex attributes, such as momentum, beginners to factor investing can focus on simpler elements, such as style (growth vs. value), size (large cap vs. small cap), and risk (beta). 

Foundations of Factor Investing

Value

Value aims to capture excess returns from stocks that have low prices relative to their fundamental value. This is commonly tracked by price to book, price to earnings, dividends, and free cash flow.

 Size

Historically, portfolios consisting of small-cap stocks exhibit greater returns than portfolios with just large-cap stocks. Investors can capture size by looking at the market capitalization of a stock.

Momentum

Stocks that have outperformed in the past tend to exhibit strong returns going forward. A momentum strategy is grounded in relative returns from three months to a one-year time frame.

Quality

Quality is defined by low debt, stable earnings, consistent asset growth, and strong corporate governance. Investors can identify quality stocks by using common financial metrics like a return to equity, debt to equity and earnings variability. 

Volatility

Empirical research suggests that stocks with low volatility earn greater risk-adjusted returns than highly volatile assets. Measuring standard deviation from a one- to three-year time frame is a common method of capturing beta.

Dividend Yield

This factor can help you identify stocks that have a higher dividend yield than the sector average. Many investors believe that such stocks tend to outperform stocks with lower yields in the long run.

Most active investors have to take an informed guess about the direction the price of a stock can take and invest accordingly. However, with factor investing, the decisions are made based on evidence or metric of the performance of securities based on certain factors. This makes factor investing more evidence-based and reliable as compared to active investing.

Our low-cost, active, factor-based funds consist of both ETFs and mutual funds, focusing on five factors that can be used in a number of ways in client portfolios to help clients meet their objectives. 

Fraction offer simplicity of investing as compared to direct equity. An investor need not analyze each stocks fundamentals and technicals or study the fund manager’s investment style in case of Fractions. Since most Fractions track indexes like Nifty, Sensex, etc. these are also suited to new investors who do not have the expertise of studying companies, economy or a funds performance.

Links.

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Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

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Prajval Madhav Uchil 

Mutual Fund Distributor. 

EUIN: E484653 l ARN 259045.

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