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3 things you should know about factor investing

3 things you should know about factor investing

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Factors are broad, persistent drivers of returns that have been proven to add value to portfolios over decades, in accordance to research data from Dartmouth College. Factor strategies like smart beta capitalize on today’s advancements in data and technology to give all investors access to time-tested investment ideas, once only accessible to large institutions. As factor strategies continue to gather attention, some misconceptions have arisen. I am highlighting—and clearing up—a few here today.

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1. Factor strategies are stocks-only.

False. Equity smart beta strategies like momentum, value, quality and minimum volatility are by far the most adopted factor strategies and often serve as the gateway to this type of investing. But it’s important to note that the concept extends beyond equities to other asset classes, such as bonds, commodities and currencies. As an example, fixed income factors are less well known but similarly aim to capitalize on market inefficiencies. Bond markets are largely driven by exposures to two macroeconomic risk factors: interest rate risk and credit risk. One way that bond factor strategies try to improve returns is by balancing those risks.

As investors look for more precise and sophisticated ways to meet their investment goals, we believe we will see more factor strategies in other asset classes, as well as in long/short and multi-asset formats.

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2. Factor investing is unnecessary because my portfolio of stocks, bonds, commodities, hedge funds and real estate is well diversified.

Maybe, maybe not. Oftentimes a portfolio is not as diversified as you might think. You may hold many different types of securities, sure, but those securities can be affected by the same risks. For example, growth risk figures prominently in public and private equities, high yield debt, some hedge funds and real estate. So as economic growth slows, a portfolio overly exposed to that particular factor will see its overall portfolio return lowering as a result, regardless of how diverse its holdings are across assets or regions.

Factor analysis can help investors look through asset class labels and understand underlying risk drivers. That way, you can truly diversify in seeking to improve the consistency of returns over time.

3. Factor investing is a passive investment strategy.

Not really. At least we don’t look at it that way. Factor investing combines characteristics of both passive and active investing, and allows investors to retain many benefits of passive strategies while seeking improved returns or reduced risk. So to us, factor investing is both passive and active. While we think traditional passive, traditional active and factor strategies all have a place in a portfolio, it is not news that some of what active managers have delivered in the past can be found through lower-cost smart beta strategies.

For more facts on factors, check out our guide and other online resources.

Sara Shores is Global Head of Smart Beta for BlackRock and a regular contributor toThe Blog.

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