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
ETMarkets.com
ETMarkets.com
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)
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.
The S&P/TSX composite index was up 171.41 points at 23,298.39.
In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.
The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.
The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.
The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.
This report by The Canadian Press was first published Aug. 29, 2024.
The crypto market has recently experienced a significant downturn, mirroring broader risk asset sell-offs. Over the past week, Bitcoin’s price dropped by 24%, reaching $53,000, while Ethereum plummeted nearly a third to $2,340. Major altcoins also suffered, with Cardano down 27.7%, Solana 36.2%, Dogecoin 34.6%, XRP 23.1%, Shiba Inu 30.1%, and BNB 25.7%.
The severe downturn in the crypto market appears to be part of a broader flight to safety, triggered by disappointing economic data. A worse-than-expected unemployment report on Friday marked the beginning of a technical recession, as defined by the Sahm Rule. This rule identifies a recession when the three-month average unemployment rate rises by at least half a percentage point from its lowest point in the past year.
Friday’s figures met this threshold, signaling an abrupt economic downshift. Consequently, investors sought safer assets, leading to declines in major stock indices: the S&P 500 dropped 2%, the Nasdaq 2.5%, and the Dow 1.5%. This trend continued into Monday with further sell-offs overseas.
The crypto market’s rapid decline raises questions about its role as either a speculative asset or a hedge against inflation and recession. Despite hopes that crypto could act as a risk hedge, the recent crash suggests it remains a speculative investment.
Since the downturn, the crypto market has seen its largest three-day sell-off in nearly a year, losing over $500 billion in market value. According to CoinGlass data, this bloodbath wiped out more than $1 billion in leveraged positions within the last 24 hours, including $365 million in Bitcoin and $348 million in Ether.
Khushboo Khullar of Lightning Ventures, speaking to Bloomberg, argued that the crypto sell-off is part of a broader liquidity panic as traders rush to cover margin calls. Khullar views this as a temporary sell-off, presenting a potential buying opportunity.
Josh Gilbert, an eToro market analyst, supports Khullar’s perspective, suggesting that the expected Federal Reserve rate cuts could benefit crypto assets. “Crypto assets have sold off, but many investors will see an opportunity. We see Federal Reserve rate cuts, which are now likely to come sharper than expected, as hugely positive for crypto assets,” Gilbert told Coindesk.
Despite the recent volatility, crypto continues to make strides toward mainstream acceptance. Notably, Morgan Stanley will allow its advisors to offer Bitcoin ETFs starting Wednesday. This follows more than half a year after the introduction of the first Bitcoin ETF. The investment bank will enable over 15,000 of its financial advisors to sell BlackRock’s IBIT and Fidelity’s FBTC. This move is seen as a significant step toward the “mainstreamization” of crypto, given the lengthy regulatory and company processes in major investment banks.
The recent crypto market downturn highlights its volatility and the broader economic concerns affecting all risk assets. While some analysts see the current situation as a temporary sell-off and a buying opportunity, others caution against the speculative nature of crypto. As the market evolves, its role as a mainstream alternative asset continues to grow, marked by increasing institutional acceptance and new investment opportunities.
