Research

Factor Investing

Factors represent investment characteristics that help explain the behavior of a security and may be used in combination with smart beta techniques to deliver efficient exposures to desired factors.

Factors help explain the behavior of a security

Investors frequently view smart beta through the lens of risk and return drivers, or factors, an academic term that is growing in adoption among practitioners. Increasingly, the two terms are used interchangeably despite core differences between the two. Factors represent investment characteristics that help explain the behavior of a security, whereas smart beta, which breaks the link between price and weight in a portfolio, can be combined with factor return premiums to deliver efficient exposures, net of transaction costs, to investors.

Factor proliferation increases the importance of
identifying robust factors

The growth in popularity of factor investing has created some confusion. The market has been flooded with an egregious number of presumed “factors” backed by positive backtests, although many may be the sole result of data mining. We believe it is more important now than ever to understand the risk preferences and/or behavioral anomalies driving factor premiums and to be skeptical of newly discovered factors.

Further Insights

Research Affiliates, our sister company, has published a number of articles on factor investing to help investors
determine if a factor is robust and to understand the inherent risks in factor investing.

Factor Timing:
Keep It Simple

Factor timing is the ability to add value to an investment strategy by altering the exposure to various factors through time. Our analysis shows that a factor-timing strategy based on a factor’s discount (or valuation) and momentum yields the most robust outcomes.

Read Paper

823-surprise-factor-betas-dont-deliver-TILE

Surprise! Factor Betas Don’t Deliver Factor Alphas

By buying or overweighting characteristics-based factor exposure and selling or underweighting beta-based factor exposure, investors can position their portfolios to reap the rewards of factor investing while bearing less risk.

Read Paper

710-alices-adventures-in-factorland-tile

Alice’s Adventures in Factorland: Three Blunders That Plague Factor Investing

Factor investing has failed to live up to its many promises. Its success is compromised by three problems that are often underappreciated by investors. Published in the Journal of Portfolio Management and also available on SSRN.

Read Paper

ra-insights-594-a-smoother-path-to-outperformance

A Smoother Path to Outperformance with Multi-Factor Smart Beta Investing

You can outperform the market with substantially lower relative risk by diversifying across simple smart beta strategies based on a half dozen robust factors. Dynamically rebalancing these factor-based smart betas significantly improves return

Read Paper

Ignored Risks
of Factor Investing

Long-only factor investing, often called smart beta, can be a valuable way for investors to achieve their long-term return targets. To achieve the best outcomes, investors should have realistic expectations about the risks factors pose and be prepared to weather potentially prolonged periods of material underperformance.

Read Paper

Strike the Right Balance
in Multi-Factor Strategy Design

Investors should not ignore the presence of real-world implementation challenges in selecting a multi-factor smart beta strategy. Thoughtful design in multi-factor investing requires a conscious and deliberate decision to find the most advantageous balance between effectively harvesting the factor premium and the costs of implementation.

Read Paper

Factor Investing

Factors help explain the behavior of a security

Factor proliferation increases the importance ofidentifying robust factors

Factor proliferation increases the importance of
identifying robust factors