Understanding Factor Investing
Factor investing combines active and passive investing for higher returns and lower risk. It bases investment decisions on macroeconomic trends and style. A new concept in India, factor investing is growing in popularity as investors optimise their portfolios.
What is Factor Investing?
Factor investing uses return drivers to diversify and manage risk. This strategy divides factors into two types:
- Macroeconomic Factors: These include broad market risks like economic growth, inflation, interest rates, and liquidity.
- Style Factors: These are asset-specific risks such as volatility, momentum, and value.
Investors can optimise portfolios by targeting these factors. Factor investing, which identifies asset class return drivers, is growing.
Key Types of Factors
- Value: Uses P/E, P/B, and debt-to-equity ratios to find undervalued stocks. These stocks outperform when their market value matches their fundamentals.
- Company Size: Small-cap stocks have higher growth potential than large-cap stocks, making them appealing.
- High-quality stocks with good governance, low debt, and consistent performance outperform over time.
- Momentum: Leverages strong past performance to gain.
- Conservative investors like low-volatility stocks because they offer better risk-adjusted returns.
- High dividend payout stocks are preferred for their long-term performance and steady income.
Benefits of Factor Investing
Factor investing offers several advantages:
- Active and passive investing: Combines active and passive strategies for precision and efficiency.
- Cost-effectiveness: Cheaper than active investing but more expensive than passive strategies.
- Evidence-Based Decisions: Uses performance metrics for accuracy and objectivity.
- Reduced Volatility: Filters stocks by investment goals to diversify.
Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.