What Is Factor Investing? How To Use It To Create Stock Portfolio?

Other than growth, value and momentum investing there is factor investing which involves targeting specific factors for return across assets. Considering the factors there are typically 2 factors namely macroeconomic and the style. Now, if you invest considering factor investing then you will able to reduce volatility, improve returns as well as also achieve diversification.

What Is Factor Investing?

Where does factor investing useful?

It has been observed that large equity funds have of late been going down in performance and instead of being going by the mutual fund route, investors with know how on the market dynamics, macro-economics can even take the route to decide on their stock portfolio and hence avoid that fee which goes out as active fund management charges.

How to use factor investing?

Typically a single attribute or factor can be used to compare and rank the top companies for investment. And investor can be overweigh on higher ranked stocks and underweight on lower ranked stocks.Typically you need to incorporate the investing principles that are otherwise employed by fund managers but without the cost element.

Notably,how the fund managers decide on being overweight or underweight on a stock is by considering factors such as growth, profitability, management control, RoE,governance and other aspects.

Factors that need to factored in factor investing

1. Value: This is determined by low P/E (lower than same industry players), P/B value

2. Growth: This is taken into account by considering the growth in earnings as well as revenue.

3. quality: Strong balance sheet and Return on equity.

4. Momentum: Long term trend in stock market prices as well as earnings growth and likewise volatility is factoring in the stability with respect to share price and corporate earnings.

5. News development around the scrip

Understanding the application of factor investing

Say if earning to price is the considered factor than say stock A has an earnings to price of 1.5 times the average E/P of the universe and another stock B that has 0.9 times the E/P of the average. Stock A then will have a tilt of 1.5 times and B a tilt of 0.9 times. Nonetheless stock A will make up just 1% of the portfolio by m-cap while stock B makes up 45.

The tilts facilitate in creating over or under weights in proportion to the factor value.

Factor investing- Advantages and constraints

In the longer run in factor investing, the various factors perform better than the benchmarks. So, at best it shall be best to consider creating or establishing portfolio considering the various factors for stabilising outperformance in the shorter term.

So, this can be taken on to by discerned investors and can be adopted to replace the funds route that involve charges of around 2% on an annual basis. If you wish to get a knack of it you can even start by establishing a paper factor portfolio and as and when you begin to understand it you can invest or put in your hard earned money. Nonetheless it is to be noted that in capital markets nothing can ascertain anything with righteousness.

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