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Factor investing aims to outperform the market by investing only in stocks that excel by certain fundamental factors. Learn more with the MoneySense Glossary.
Factor investing is a rules-based strategy targeting securities with fundamental characteristics that research has shown drive above-average returns. Factor-based funds and benchmarks typically take an index such as the S&P 500 and filter it to create a portfolio focused on the desired factor.
The most common factors are:
The definitions used for these factors may vary between funds. For instance, value may be defined as low price-to-book value, a low price-to-earnings ratio or other metrics. Additionally, some products focus on a single factor while others target multiple factors. Most factors perform best during certain phases of the economic cycle.
Many people now use the term factor investing interchangeably with smart beta. Some experts disagree with that characterization, however, arguing that smart beta is a subset of factor investing. BlackRock, for instance, one of the world’s largest asset managers, offers both rules-based smart beta funds as well as sophisticated multi-asset strategies designed to profit from macroeconomic factors such as economic growth, inflation and changes in interest rates.
Example: “According to BlackRock research, the best time to invest in the value factor is early in the economic cycle. After performing poorly in 2018 and 2019, value surged in 2021 and 2022 as the economy recovered from the COVID-19 pandemic.”
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