what is 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 investingfactor 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 since traditional portfolio allocations like 60 stocks and 40 bonds are relatively easy to implement 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 these attributes are readily available for most securities and are listed on popular stock research websites foundations of factor investingvalue 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 1historically 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 2stocks 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 3quality is defined by low debt stable earnings and consistent asset growth investors can identify quality stocks by using common financial metrics like a return to equity debt to equity and earnings variability 4empirical research suggests that stocks with low volatility earn greater risk adjusted returns than highly volatile assets 5 measuring standard deviation from a one to three year time frame is a common method of capturing beta example the fama french 3 factor modelone widely used multi factor model is the fama and french three factor model that expands on the capital asset pricing model capm built by economists eugene fama and kenneth french the fama and french model utilizes three factors size of firms book to market values and excess return on the market in the model s terminology the three factors used are smb small minus big hml high minus low and the portfolio s return less the risk free rate of return smb accounts for publicly traded companies with small market caps that generate higher returns while hml accounts for value stocks with high book to market ratios that generate higher returns in comparison to the market 6