Learning This Week: Factor Investing
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In the last few weeks, I delved briefly into the EV value chain and the geopolitics of EV battery minerals. Last week we took a peek into another fascinating topic - Famous Quant Investors. Today, we delve deeper into factor investing.
Factor Investing is the strategy of targeting securities with specific characteristics like value, quality, momentum etc. They are components that are traditionally looked into by every investor but not applied systematically. They are present and persistent in every market and economic cycle and are well documented. Factor investing allows investors to approach diversification in an organised and rational manner and provide better returns than the market indices.
Factor investing is based on identifying those “factors” that help a particular security provide better returns than an aggregate set of stocks like an index. Some of the most prominent factors are:
Value Factor:
The value factor is a measure of a company's stock price relative to its fundamentals, such as earnings, book value, and cash flow. A higher Value Factor indicates that the company is undervalued, while a lower Value Factor indicates that the company is overvalued. The Value Factor is used by investors to identify stocks that may be undervalued and therefore offer potential for higher returns.
The Momentum Factor
The Momentum Factor is an investment strategy that seeks to capitalize on the tendency of stocks that have had strong recent performance to continue to outperform in the future. The strategy involves buying stocks that have outperformed the market over a certain period of time, and selling those that have underperformed. The strategy is based on the idea that stocks that have recently done well have momentum and will continue to do well, while those that have recently done poorly will continue to do poorly.
Growth Factor
The Growth Factor in investing is a measure of how quickly the revenues or profits of an investment have grown over a period of time. It is calculated by taking the percentage change in the value of the revenues or profits over a given period and dividing it by the number of years in the period. The higher the growth factor, the faster the investment has grown.
Quality Factor
The Quality Factor is an investment strategy that focuses on investing in companies with strong fundamentals, such as high return on equity, low debt, and strong management. Quality stocks tend to outperform the market over the long term, as they are less volatile and have a higher probability of delivering consistent returns. Quality stocks also tend to be less affected by market downturns, as their fundamentals are more resilient. Quality stocks are typically more expensive than other stocks, but the higher price is often justified by the higher expected returns.
Low Size Factor
The Low Size factor is a measure of a company's size relative to the overall market. Companies with a low size factor are typically smaller than the average company in the market. These companies tend to be more volatile and have higher risk than larger companies. They also tend to have lower liquidity, making it more difficult to buy and sell shares. Investing in smaller companies can be riskier, but it can also offer higher potential returns.
Low Volatility Factor
The Low Volatility factor is an investing strategy that seeks to identify stocks that have historically had lower volatility than the overall market. This strategy is based on the idea that lower volatility stocks tend to outperform the market over the long term. Low volatility stocks are typically characterized by their low beta, which is a measure of a stock's volatility relative to the market. Low volatility stocks tend to be more defensive in nature and are often found in sectors such as consumer staples, utilities, and healthcare. Low volatility stocks may also have higher dividend yields and lower price-to-earnings ratios than the overall market.
Summary
These are just a few factors and definitely not the entire list. Anyone can research and come up with any other factor which can be demonstrated to provide excess returns over an index. Creating an equity portfolio which focuses on a single or a combination of factors can produce index-beating returns.
The factors can be based on either fundamental or technical data or a combination of these.
DISCLAIMER:
Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.
SEBI Registered Research Analyst - Cupressus Enterprises Pvt Ltd - INH000013828.
Registration granted by SEBI and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.
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