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What “Factors” Count in Investing?

What “Factors” Count in Investing?

| July 09, 2019
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The last number of years have seen multiple new investing philosophies and strategies gain traction with investors, both retail and institutional.  Beyond traditional fundamentals focused investing, in which decisions are made based on a company’s strategic positioning, growth rates, valuation, management, etc., some of these new areas include investing based upon:

  • Quantitative Analysis
  • Macroeconomic developments and trends
  • Algorithms
  • Technical Analysis

More recently, a new approach has quickly been gaining traction - investing based on Factors.  According to a recent Morningstar report, currently almost $800B is now invested across approximately 1,500 Factor based ETFs.  This is an increase from $700B last year and $600B two years ago.  We believe this is an interesting investment thesis and have recently started to utilize Factor products in our recommended portfolios. 

What are Factors?

Factors are characteristics of a stock, or stocks, which have historically proven to be consistent predictors and explainers of risk and performance.  Factors are categorized as Macroeconomic or by Style.  Specific Macroeconomic factors include economic growth, real rates, inflation, credit, emerging markets, and liquidity.

Style factors, which are our main focus include:

  • Value
  • Momentum
  • Minimum Volatility
  • Size
  • Quality

The Value factor, as the name describes, is focused on inexpensive stocks based on valuation ratios.  These ratios may be based on any of the following metrics: price to book, price to earnings, dividend yield, cash flow, etc.  Lower valuations companies have earned higher returns over time relative to higher valued companies.

The Momentum factor incorporates past relative performance of a stock’s return.  This may be measured based on past 3 months, 6 months, and/or 12 months excluding the prior last month. Minimum Volatility captures returns above a benchmark with lower than average beta.  Standard deviation is used as a measure of volatility. The Size factor highlights the history of small capitalization stocks outperforming relative to larger cap stocks.  Lastly, Quality is defined by the excess return due to metrics such as low debt, volatility of earnings, and ROE.  Fundamental details such as dividend growth, balance sheet strength, leverage, and cash flow are used as measures for the Quality factor.

Benefits of Utilizing Factors

Standard fundamental analysis can lead to a portfolio that may have a number of attractive attributes to the manager such as low P/E to growth, growing dividends, etc.  But there can be long periods of time when the specifics behind stock selection are not recognized and a portfolio will lag its benchmark.  Also, the manager, while running a diversified portfolio across industries and sectors may fail to realize the various stocks may actually have many of the same exposures.  While there may be a specific thesis justifying owning each holding, what ultimately matters is when the rest of the market will gain such appreciation.  Hence, being aware of Factor positioning can help to diversify the portfolio and provide a number of benefits that would be difficult to achieve solely through bottoms up stock picking. 

Just as important as recognizing the different dynamics that can drive performance, investors should appreciate the actual alpha generating potential of focusing on factors.  A skilled portfolio manager can trade factors tactically resulting in outperformance.  This requires a different approach than fundamental analysis and focused thinking about market dynamics and which factors will do well at different points during the economic cycle.  The chart below highlights how some factors have done relative to the S&P 500 over time.

      Of course, tactfully investing in factors successfully, just as trading stocks, requires insights into which factors will be in and out of favor over the course of a full business cycle. 

   More specifically:

   Factor Strategies: Success in various market phases

As can be seen from the chart, during the dot com bubble, the Momentum factor exponentially outperformed both the Value and Quality factors.  This is consistent with the attraction at the time to companies that did not have earnings.  Post the internet bubble bursting, there was a resurgence in Small Cap stocks and Value recovered.  Interestingly, Low Volatility stocks did relatively well when there was a lot of consternation about the markets and the economy. 

One more important differentiator of Factor based strategies is how they can perform relative to market cap based strategies.  Market cap based strategies may ultimately depend on how a few large companies perform and can potentially dominate the returns of an index.  Also, due to weightings in benchmarks, liquidity needs, etc., market cap based strategies do not leave much room for the manager to express an opinion.  Hence, factor based strategies may provide more diversification.  Whether Factor investing is utilized, high-level asset allocation decision will still dominate portfolio results.  We favor a multifactor approach rather than single-factor implementation, as diversification properties can be quite beneficial in managing the unpredictable nature of short-term factor risks.


Factor investing is a strategy that can help to diversify a portfolio, manage the risk exposures that may not be obvious to the manager, and can be used tactfully as another type of investment or asset class.  Size, Value, Momentum, Volatility, and Quality typically constitute the set of rewarded factors.  Although the industry has not yet reached a consensus on why these factors work, there is considerable and convincing evidence on the persistence of excess return associated with these factors.  While we believe that Factor investing can be an efficient, cost-effective solution for investors, we recognize there are no “one size fits all” solution in the world of investing and Factor investing is no exception.   At Tompkins Financial Advisors, we utilize Factor investing product in our recommended strategies and would encourage you to reach out to your local Tompkins Financial advisor to learn more.


Jeff Benjamin, “The growth of factor-based investing,” Investment News, 5/18/2019

“Basic concepts for understanding factor investing,” Invesco

Andrew Innes, “The Merits and Methods of Multi-Factor Investing,” S&P Dow Jones Indices, April 2018

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