- Factor investing works on principles based on quality, low volatility, value
Factor investing has been prevalent in the market for the last several decades. Notable investors like Benjamin Graham and Warren Buffet are also gaining interest from investors including Fama and French and there is a lot of academic literature on equity factor investing available in the market. Equity factor investing is based on a portfolio of securities. For example, the value factor is a portfolio of undervalued stocks and the momentum factor is a portfolio of stocks that have given the highest return over a specified period. The most commonly used factors are value, quality, momentum, growth, size and low volatility, said Sukanya Dhosh, fund manager at SBI Mutual Fund.
Factor Investing is popular among global investors due to its transparency, disciplined investment principles, ability to build diversified portfolios and strong presence in the market for a long time. We often forget that monitoring market dynamics through factors is a complementary approach to macroeconomic cycles and helps to understand patterns and trends of stocks and sectors. Understanding market movements as well as equity factor performance also provides an opportunity.
Globally, value was more dominant in the early decades of the century. Values have made a comeback in 2021-22 after decades of dominance of momentum and growth. Quality being a protective factor has outperformed during the global financial crisis. India has primarily been a market where growth and quality factors have steadily advanced over time. However, it works according to different markets. Quality is the most performing factor when the market is depressed. While the growth factor prefers to invest in companies that have recorded high growth in revenue.
A factor-based approach to investing reduces volatility This year, the value-based factor has become more useful in the market. The quality factor is also again at play. A multi-factor approach to investing helps reduce the volatility of individual factors in addition to diversification. It also serves to reduce the magnitude of some other risks of slowdown in the market.
Investing requires identifying a specific style An in-depth understanding of investment outlook and certain characteristics is essential during multiple market regimes, which helps us align the portfolio as per the market outlook. During each reign some styles overtook others. Investing according to current market trends can make the process of portfolio building much easier.
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