Factor investing is an investment approach that involves targeting quantifiable firm characteristics or “factors” that can explain differences in stock returns. Security characteristics that may be included in a factor-based approach include size, low-volatility, value, momentum, asset growth, profitability, leverage, term and carry.
There are two main types of factors: macroeconomic and style. Investing in factors can help improve portfolio outcomes, reduce volatility and enhance diversification.
Factor investing utilizes multiple factors, including macroeconomic as well as fundamental and statistical, are used to analyze and explain asset prices and build an investment strategy.
Factors that have been identified by investors include growth vs. value; market capitalization; credit rating; and stock price volatility - among several others.
Smart beta is a common application of a factor investing strategy.