Factor investing is an investment strategy where the fund managers select stocks based on particular attributes. These attributes are the driving force behind stock returns.
For example, someone selecting stocks that are undervalued is investing in value as a factor.
Mainly, there are two kinds of factors: Macroeconomic factors and Style factors. Macroeconomic factors which are not directly correlated with the financial assets yet affect their prices. For instance, GDP growth, Interest rate, Inflation, and so on.
Style factors, on the other hand are directly related to and indicate the risk and returns within the asset classes. Some of the style factors are value, quality, size, momentum, etc.
In factor investing, your portfolio may be constructed based on a single factor or multiple factors. For example, momentum funds include those financial securities which have shown upward price movements in the last six-twelve months.
Here, momentum is a single factor used while constructing a portfolio. You will find many funds based on a single factor like value, momentum, or quality.
An example of multi-factor investing can be a value and low volatility fund, in which only those stocks which are undervalued and have lower variation in the prices over time would be included.
Research also suggests that Warren Buffett’s stock-picking styles can be explained by factors.
Researchers have shown that to duplicate his returns, one can use quality, value and low-volatility factors.
Why is Factor Investing better than Traditional Investing? Factor investing proves to be a better investment strategy on the following parameters.
1) Performance
The old-school way of building a portfolio of stocks is where fund managers do fundamental research by studying how a specific company is doing compared to its competitors and its management and the reasons why a sector or a company is likely to do well in the future.
Factor investing is a rule-based investment strategy that strategically selects stocks having specific attributes.
For example, a momentum factor fund would rank all the stocks in its universe based on momentum score and then rank the stocks and give them weights, and these weights could be either equal-weighted or weights dependent on its momentum score.
Similarly, in a multi-factor model, all the stocks are ranked based on multiple factors, and a portfolio is constructed. The actual value is created when algorithms can give weights to different factors that are likely to do well in current market scenarios.
Let’s take a look at the factor indices created by NSE. This analysis is from 1st April 2005 to 30 April 2022
We can see that all the factors have been able to beat the index over the last 17 years. Value as a factor has not been too well over 17 years, but over the last year or so, it has done quite well.
Also, if we look at the volatility, which is a measure of risk, all the factors except Value have lower risk than the Nifty50.
In fact, the low volatility factor has the least volatility and even with such a low risk, it has been able to beat the index.
2) Better Transparency Factor investing provides you with more transparency than traditional investing. In traditional investing, the reason for poor returns or poor performance can be a mystery for you. However, when you have invested in a factor-based fund, you can easily understand the reason for the performance of the fund.
3) Low cost
Factor investing involves codifying the rules and identifying suitable opportunities. Therefore, the fund manager is not required to put much effort into managing the portfolio. Consequently, the cost associated with factor investing is lesser than that of a traditional active investment strategy.
4) Diversification
One issue you may have noticed is that when the market is down, your entire portfolio is in red. This is because you are putting all your eggs in one basket.
For example, you have invested only in companies based on market capitalization or specific sectors. Factor investing lands a helping hand here.
When you invest in a multi-factor fund, where factors are less correlated, you end up with a well-diversified portfolio.
Therefore, when one factor is not working, another may work and you may be saved from being a victim of a market fall.
5) Eliminate human bias
One of the problems with traditional investing is the existence of human bias. You may make the decision partially based on your judgment. You may end up investing in poor-performing stock, or you may avoid the stock performing actually well.
Moreover, you may panic when the market is falling or may get lured when the market is going up. This usually happens in traditional investing due to human emotions.
You might argue that investing via mutual funds may eliminate this bias because the fund manager is clear about his investment strategies and goals. We are forgetting that even funds are managed by humans.
No matter how strategic a manager is, there are chances of biases. Factor investing solves this problem by avoiding human bias and qualifying the stocks based on logic.
Conclusion
To wrap up, factor investing is a more objective, systematic, and evident approach to investing. When the traditional investment approach is likely to leave you with market-like returns, lower diversification, and higher risk, factor investing comes to the rescue.
With factor investing, you are more likely to get a diversified portfolio with lower risk exposure and better returns.
(The author is Director (strategy) at Estee Advisors and head of investments at Gulaq, a part of Estee Group)
(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of Economic Times)
John Ivison: The blowback to Trudeau's investment tax hike could be bigger than he thinks – National Post
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April 19, 2024
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The numbers from the Department of Finance suggest they have struck taxation gold. But they’ve been wrong before
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Published Apr 19, 2024 • Last updated 8 hours ago • 5 minute read
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“99.87 per cent of Canadians will not pay a cent more,” the prime minister said this week, in reference to the budget announcement that his government will raise the inclusion rate on capital gains tax in June.
The move will be limited to 40,000 wealthy taxpayers. “We’re going to make them pay a little bit more,” Justin Trudeau said.
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But it’s hard to see how that number can be true when the budget document also says 307,000 corporations will also be caught in the dragnet that raises the inclusion rate on capital gains to 66 per cent from 50 per cent.
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Many of those corporations are holding companies set up by professionals and small-business owners who are relying on their portfolios for their retirement.
The budget offers the example of the nurse earning $70,000 who faces a combined federal-provincial marginal rate of 29.7 per cent on his or her income. “In comparison, a wealthy individual in Ontario with $1 million in income would face a marginal rate of 26.86 per cent on their capital gain,” it says.
Policy wonks argue that the change improves the efficiency and equity of the tax system, meaning capital gains are now taxed at a similar level to dividends, interest and paid income. The Department of Finance is an enthusiastic supporter of this view, which should have set alarm bells ringing on the political side.
That’s not to say it’s not a valid argument. But against it you could put forward the counterpoint that capital gains tax is a form of double taxation, the income having already been taxed at the individual and corporate level, which explains why the inclusion rate is not 100 per cent.
The prospect of capital gains is an incentive to invest particularly for people who, unlike wage earners, usually do not have pensions or other employment benefits.
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That was recognized by Bill Morneau, Trudeau’s former finance minister, who said increasing the capital gains rate was proposed when he was in politics but he resisted the proposal.
Morneau criticized the new tax hike as “a disincentive for investment … I don’t think there’s any way to sugar-coat it.”
Regardless of the high-minded policy explanations that are advanced about neutrality in the tax system, it is clear that the impetus for the tax increase was the need to raise revenues by a government with a spending addiction, and to engage in wedge politics for one with a popularity problem.
The most pressing question right now is: how many people are affected — or, just as importantly, think they might be affected?
One recent Leger poll said 78 per cent of Canadians would support a new tax on people with wealth over $10 million.
But what about those regular folks who stand to make a once-in-a-lifetime windfall by selling the family cottage? We will need to wait a few weeks before it becomes clear how many people feel they might be affected.
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The numbers supplied to Trudeau by the Department of Finance suggest they have struck taxation gold: plucking the largest amount of feathers ($21.9 billion in new revenues over five years) with the least amount of hissing (impacting just 0.13 per cent of taxpayers).
The worry for Trudeau and Finance Minister Chrystia Freeland is that Finance has been wrong before.
Political veterans recall former Conservative finance minister Jim Flaherty’s volte face in 2007, when he was forced to drop a proposal to cancel the ability of Canadian companies to deduct the interest costs on money they borrowed to expand abroad.
“Tax officials vastly underestimated the number of taxpayers affected when it came to corporations,” said one person who was there, pointing out that such miscalculations tend to happen when Finance has been pushing a particular policy for years.
Trudeau’s government has some experience of this phenomenon, having been obliged to reverse itself after introducing a range of measures in 2017, aimed at dissuading professionals from incorporating in order to pay less tax. It was a defensible public policy objective but the blowback from small-business owners and professionals who felt they were unfairly being labelled tax cheats precipitated an ignoble retreat.
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Speaking after the budget was delivered, Freeland was unperturbed about the prospect of blowback. “No one likes to pay more tax, even — or perhaps more particularly — those who can afford it the most,” she said.
She’d best hope such sanguinity is justified: failure to raise the promised sums will blow a hole in her budget and cut loose her fiscal anchors of declining deficits and a tumbling debt-to-GDP ratio.
That probably won’t be apparent for a year or so: the government projected that $6.9 billion in capital gains revenue will be recorded this fiscal year, largely because the implementation date has been delayed until the end of June. We are likely to see a flood of transactions before then, so that investors can sell before the inclusion rate goes up.
After that, you can imagine asset sales will be minimized, particularly if the Conservatives promise to lower the rate again (though on that front, it was noticeable that during question period this week, not one Conservative raised the new $21 billion tax hike).
The calculated nature of the timing is in line with the surreptitious nature of the narrative: presenting a blatant revenue grab as a principled fight for “fairness.” The move has the added attraction of inflicting pain on the highest earners, a desirable end in itself for an ultra-progressive government that views wealth creation as a wrong that should be punished.
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Trudeau’s biggest problem is that not many voters still associate him with principles, particularly after he sold out his own climate policy with the home heating oil exemption.
The tax hike smacks of a shift inspired by polling that indicates that Canadians prefer that any new taxes only affect the people richer than them.
Success or failure may depend on the number of unaffected Canadians being close to the 99.87-per-cent number supplied by the Finance Department.
History suggests that may be a shaky foundation on which to build a budget.
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Traders had hoped by now the Federal Reserve would be free to start cutting interest rates — boosting rate-sensitive stocks and unlocking a largely frozen real estate market. Instead, stubborn price growth has some on Wall Street rethinking whether the central bank will lower rates at all this year.
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