What is "Factor Investing"?

AmericaFirst investment strategies combine rules-based modelling with factor investing.

Rules-based modelling involves applying a targeted set of rules by which future holdings are derived.  The sets of rules typically screen a set of factors.  Factor investing is a strategy that chooses securities on attributes that are associated with historically higher returns.

Commonly Used Factors

Commonly used rules-based factors may include:

  • Size

    • Represents the potential higher-than-benchmark returns associated with relatively smaller stocks within the universe being considered as measured by market capitalization.

  • Value

    • Applies to investments trading at discounts to similar securities, based on “price-to” measures like price-to-earnings, price-to-book, and price-to-cash ratios.

  • Momentum

    • Identifies investments with positive momentum (recent strong returns) or negative momentum (recent weak returns).

  • Low Volatility

    • Describes investments that have demonstrated the lowest volatility compared with securities in the same asset class.  Often measured by historical Beta or Standard Deviation.

  • Quality

    • Characterizes companies with strong measures of financial health, including a strong balance sheet and statements of cash flow.

  • Dividend Yield

    • Reflects stocks that have paid higher dividend yields and generated higher total returns over time than lower-yielding assets.

  • Risk On / Risk Off

    • Describes a process where investors move to riskier potentially higher yielding investments and then back again to supposedly lower yielding investments which are perceived to have lower risk.  Risk On / Risk Off factors include macro measurements such as Unemployment as well as technical indicators such as the Relative Strength Index (RSI) as applied to the broad markets.

Factor investing, for patient investors who understand the risks, has the potential to improve a portfolio’s long-term risk-adjusted return, especially when strategies used are transparent, use sufficiently researched factors, and have good implementation characteristics.