Factor-based investing is a method that focuses on specific attributes, or “factors,” which historically have influenced the performance of stocks and bonds. This approach is rooted in decades of financial research and seeks to enhance portfolio construction by tapping into characteristics that may drive higher risk-adjusted returns over time. In this article, we’ll explore what factor-based investing is, why it matters, and how it may serve as a powerful tool for investors seeking long-term growth.
What is Factor-Based Investing?
Factor-based investing is built on the idea that certain broad, persistent, and historically observable attributes, known as factors, may help explain the behavior of asset prices. These factors are used to identify securities that may have higher potential for outperformance or lower relative risk over time. The most commonly identified factors include:
- Value: Securities that are priced lower relative to their fundamentals (e.g., earnings, cash flow, or book value) fall into the value category. Research suggests that value stocks have historically outperformed growth stocks in the long run, although this is not always the case over short periods.
- Size: The size factor emphasizes investing in smaller companies, which may have higher growth potential compared to large-cap firms. Historically, smaller companies have outperformed larger companies, though they may come with higher volatility.
- Quality: The quality factor refers to companies with strong profitability, low debt levels, and stable earnings. These companies may tend to outperform those with weaker financial fundamentals.
These factors were identified through rigorous academic research and data analysis. Nobel laureates Eugene Fama and Kenneth French are pioneers in factor-based investing, having developed the three-factor model that includes value, size, and market exposure as key components for explaining stock returns. Over time, additional factors such as momentum and quality have been added to the investment toolkit.
Why Factor-Based Investing Matters
Factor-based investing matters because it provides a framework for understanding and managing risk while attempting to capture potential excess returns. By using factors to construct portfolios, investors may be able to diversify their risk exposure beyond traditional asset classes, such as stocks and bonds, and potentially improve their long-term outcomes.
Here are several reasons why factor-based investing could be relevant to your investment strategy:
- Risk and Return Drivers: Factors represent some of the most reliable risk and return drivers in financial markets. Historical data shows that certain factors, like value and size, have tended to outperform the broader market over long periods. While there are no guarantees, understanding how factors drive returns may help investors manage their risk exposure more effectively.
- Diversification: While traditional diversification involves spreading investments across asset classes (such as stocks, bonds, and cash), factor-based investing adds another layer of diversification by focusing on the underlying characteristics of the securities themselves. For example, including both value and momentum factors in a portfolio may potentially balance returns across different market environments.
- Evidence-Based Approach: Factor-based investing relies on academic research and historical data, rather than speculative market timing or short-term trading strategies. By leveraging a data-driven approach, investors may avoid the pitfalls of emotional decision-making, which can negatively impact portfolio performance.
- Potential for Enhanced Risk-Adjusted Returns: Factor-based strategies may offer the potential to improve risk-adjusted returns by targeting specific characteristics that have historically been linked to outperformance. For example, the quality factor has shown that companies with strong financial health may experience better long-term returns compared to less financially sound firms.
- Cost Efficiency: Many factor-based strategies can be implemented through exchange-traded funds (ETFs) or mutual funds, which tend to have lower fees than traditional actively managed funds. These products may provide broad exposure to desired factors while keeping costs low. However, fees and expenses can vary, and it’s essential to evaluate the cost structure of each fund before investing.
The Challenges and Risks of Factor-Based Investing
Like any investment approach, factor-based investing has its challenges and risks. Understanding these risks is crucial when determining whether this strategy is appropriate for your financial goals and risk tolerance.
- Cyclicality: Factors may perform well during specific periods and underperform during others. For example, value stocks have historically outperformed growth stocks, but there have been extended periods where growth stocks dominated. Investors need to be prepared for the cyclicality of different factors and avoid abandoning a factor during temporary underperformance.
- Overfitting Risk: The success of certain factors in the past does not guarantee that they will perform well in the future. Overfitting, or relying too heavily on historical data, might lead to overconfidence in the persistence of these factors. It’s essential to maintain realistic expectations and recognize that market conditions change over time.
- Implementation Risks: While factor-based ETFs and mutual funds are accessible to most investors, implementation can still present risks. Some funds may deviate from their stated factor exposure, leading to unintended results. It’s important to thoroughly research the funds you’re considering and ensure they align with your investment strategy.
- Concentration Risk: Focusing too heavily on one factor could expose a portfolio to unwanted risks. For example, a portfolio weighted heavily toward value stocks might struggle during periods when growth stocks are favored. To mitigate concentration risk, a multi-factor approach, combining several factors, might provide more balanced exposure.
How to Incorporate Factor-Based Investing into Your Portfolio
For investors interested in incorporating factor-based strategies, it’s essential to start with a clear understanding of your investment objectives and risk tolerance. Factor-based strategies can be tailored to fit various financial goals, but they are not a one-size-fits-all solution.
Some investors choose to adopt a multi-factor approach, diversifying across multiple factors like value, size, and quality. This strategy may help manage risk by balancing the cyclical nature of individual factors. However, even multi-factor strategies require patience and discipline, as no single factor consistently outperforms in all market environments.
Before incorporating factor-based investing into your portfolio, it’s essential to:
- Assess Your Risk Tolerance: Determine your willingness and ability to take on risk, as certain factors, like size and momentum, may introduce more volatility.
- Consider Costs: Factor-based ETFs and mutual funds may have lower costs compared to traditional actively managed funds, but it’s important to compare fees across different products.
- Stay Informed: Keep up with the latest academic research and market trends that may impact factor performance. Staying informed can help you adjust your strategy as necessary without reacting impulsively to short-term market movements.
Conclusion
Factor-based investing offers a disciplined and evidence-based approach to portfolio construction that attempts to capitalize on characteristics that have historically influenced market returns. While it may provide potential advantages like diversification and enhanced risk-adjusted returns, it also comes with its share of risks, including cyclicality and implementation challenges.
Investors should carefully consider their financial objectives, risk tolerance, and investment horizons before incorporating factor-based strategies into their portfolios. A thoughtful, research-driven approach may help align factor-based investing with long-term investment goals.
If you have any questions, please do not hesitate to contact us.
For additional insight please read Chapter 5 of Wealth on Purpose by Bryan Ballentine.
Sources: Located at the bottom of the article
Golf Tip of the Week:
As golf season winds down, now’s the time to address your lower-back issues
If you want to know how golf-fitness trainers make their car payments and get their children through college, it’s helping average players like you cope with lower-back pain. It’s the single most common problem area for golfers, says Lindsay Becker, one of Golf Digest’s 50 Best Fitness Trainers in America.
Becker, who trains tons of golfers at Buckeye Performance Golf in Dublin, Ohio, says people often mistakenly miss the true cause of their back pain because they are only focused on where it hurts.
“Many of my golfers, especially males over age 40, are lacking rotational mobility in the joints needed to rotate—mainly the hips and upper back. The lower back, which is designed to have minimal rotation, starts trying to compensate for poor rotational mobility of the hips and/or upper back. Combine that with poor posture at setup, and you have a perfect storm brewing for low-back pain.”
Becker, who is a Golf Digest Certified Fitness Trainer, has a three-part remedy for your issues if you’re feeling the pain, so to speak. With golf season winding down for many, now is the time to get in the gym and start improving your rotational mobility. All you’ll need is a bar or similar (broomstick, etc.) and a resistance band that you can anchor to something.
Here are her back fixes for you. Do these exercises as often as you can, and remember to work both sides of the body equally:
POSTURE DRILL
“So many golfers I work with set up with an anterior pelvic tilt or arched lower back,” she says. “This position limits the rotational capability of your hips and places excessive stress on your spine.
“To achieve good posture, start with stick/club behind your back. When you bend over into golf posture, the club should touch your upper back, lower back and butt.”
Half-kneeling rotations to overheads
“Get in a half-kneeling position with left knee down and right leg in front. Holding a club, rotate your upper body to the right, then extend your arms overhead. Take a deep breath (inhale/exhale) in this position, and then return to the start. This works on upper-back mobility as well as upper-lower body separation.”
Tall kneeling to half-kneeling band holds
“Start with both knees down and holding a band in front of you at torso height. Bring the outside leg up in front, moving into a half-kneeling position, then return to the tall-kneeling start position (both knees down). Try not to lean your body as you are moving your leg. This works on hip mobility of the moving leg and stability of the core and stance leg.”
Golf Tip adapted from golfdigest.com i
Recipe of the Week:
Scalloped Potatoes
Ingredients
1 clove garlic, smashed
2 tablespoons unsalted butter
2 1/4 pounds Yellow Finn potatoes or other waxy-style potatoes
2 cups half-and-half
1 tablespoon kosher salt
Freshly ground black pepper
Pinch nutmeg
Directions
- Preheat the oven to 350 degrees F. Rub the garlic around the inside of an 8 by 8 by 2-inch casserole dish and let it dry. Reserve the remaining garlic. Rub the butter around the inside of the dish. Reserve the remaining butter.
- Peel and thinly slice the potatoes on a mandoline or vegetable slicer (about 1/8-inch-thick slices).
- In a medium saucepan, combine the garlic, butter, potatoes, half-and-half, salt, pepper to taste, and nutmeg. Bring to a boil, lower the heat to medium-high, and cook, stirring, until the mixture has thickened, about 5 minutes. Transfer the mixture to the prepared dish. Shake the pan so the potatoes are distributed evenly.
- Bake the potatoes, basting occasionally, until lightly browned and bubbly, about 1 hour. Remove from the oven and let cool for 10 minutes before serving.
Recipe Tip adapted from foodnetwork.com ii
Travel Tip of the Week:
I’m a Professional Packer and These Are the Things I’ve Regretted Packing in My Carry-on
Properly packing a carry-on suitcase is equally about what you pack as it is what you don’t. Learn from my mistakes and leave these not-so-essential items behind.
The stakes are high when it comes to packing, especially if you choose just to bring a carry-on.
The standard carry-on size is a mere 22 inches tall, 14 inches wide, and nine inches deep — and that’s including the wheels and handle. That means space is at a premium. Everything you pack must serve a purpose — and if it doesn’t, it must remain at home. That rule of thumb may seem harsh, but it’s a practice that will save travelers from the dread of overpacking.
As a professional packer and founder of travel style site Just Packed, I’ve come to realize my own overpacking has one main cause: uncertainty. This stems from trying to prepare for too many situations at once, including different weather conditions, dress codes, or what I may or may not be doing at my final destination. (What if I need hiking clothes and my regular working out clothes? I can fit two dresses in my suitcase, but what if they aren’t quite elegant enough for dinner?) The process gets exponentially more complicated as the length of a trip increases.
Before I finally perfected the art of the expertly packed carry-on suitcase, I failed. And I failed a lot. In my years of not-so-successful packing attempts, I found myself paying overweight luggage fees, miserably hauling around heavy backpacks, and praying the flight attendants ignored my overstuffed personal item that didn’t fit under the seat in front of me. But they say experience is the best teacher, and along with now having a good grasp on what to bring with me for any trip, I also have first-hand experience on what not to pack.
To help you properly pack your carry-on suitcase, I’m sharing everything I’ve regretted packing in mine. Read on to learn from my mistakes and how to save your valuable suitcase real estate for the items you’ll actually need on your trip instead.
Heels I can’t walk in
A 20-year-old version of myself thought 6-inch heels were essential for a weekend in New York City. What I didn’t realize was how much walking I’d be doing — and how much the heels would weigh down my bag. Not only did they not last through the night, but I could’ve used that suitcase space for something more practical. These days, if I need to bring a pair of heels, I grab a pair of block heels — ideal for summertime or warmer climates — and slingbacks for a more seasonally appropriate fall or winter style.
A heavy raincoat
I recently spent four months traveling in England, and I didn’t use my raincoat once. Umbrella, yes, several times, but the raincoat stayed in my suitcase. My stylish trench coat got plenty of wear, and the weighty raincoat just took up precious room. On my next trip across the pond, I’ll bring a packable rain poncho instead.
A bulky neck pillow
Repeat after me: There are better, more travel-friendly options than a standard neck pillow. That hour of sleep you’ll get using your pillow is not worth the annoyance of bringing the bulky travel accessory along for the journey. I now leave behind my old travel pillow, preferring the AirComfy Ease pillow for overnight flights. On any non-red-eye flight, I sacrifice sleep and comfort in favor of having extra room in my carry-on or personal item.
The wrong adapter
Doing your research before a trip includes understanding your destination’s plug and outlet types. This will save you from arriving in France, like I once did, with an adapter that only worked for sockets in the United Kingdom and Ireland. Now I always bring a universal travel adapter — just in case I get an urge to buy a last-minute ticket to another country.
Dry clean only clothing
If you’re planning to re-wear the clothing you bring in your suitcase, then check the tags first. If your clothes get soiled on your trip, you’ll want the option of washing them. While your Airbnb may have a laundry room, finding a dry cleaner (and waiting a few days for your clothes to be ready) isn’t always in the cards. You don’t want to end up with a sweater or dress that not only takes up space in your suitcase but if it gets stained, it can’t be worn again. Look for travel clothing that specifically says it can be washed in a washing machine; cotton, spandex, and nylon are usually safe bets.
Excessive skincare products
I have a vested interest in my skincare routine. When I’m at home, I never stray the course when it comes to the order and application of products: toner, Vitamin C, and SPF in the morning; cleanser, retinol, and moisturizer at night. However, bringing the entire skincare routine along in my toiletry bag is a nuisance, especially as most of the products don’t fall into the 3.4-ounce and under TSA rule. I can also attest to the pain you experience when the TSA agent disposes of your expensive serums and sunscreen because they’re just slightly larger than the liquid allowance.
Now, when I fly without a checked bag, I bring a travel-sized version of an all-in-one product. Augustinus Bader’s The Cream comes in a 0.5-ounce bottle, and while on the pricier side, it does the work of a handful of products, including my Vitamin C and anti-aging serums and moisturizer. Fewer skincare products in my carry-on, more room for everything else.
Lydia Mansel is a travel writer and founder of Just Packed, a stylish traveler’s resource for packing lists and product recommendations. Most of her frequent flier miles come from trips to the United Kingdom, but she’ll fly anywhere in search of a hotel with soft sheets, fluffy robes, and top-tier room service.
Travel Tip adapted from travelandleisure.com iii
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Ballentine Capital Advisors is a registered investment adviser. The advisory services of Ballentine Capital Advisors are not made available in any jurisdiction in which Ballentine Capital Advisors is not registered or is otherwise exempt from registration.
Please review Ballentine Capital Advisors Disclosure Brochure for a complete explanation of fees. Investing involves risks. Investments are not guaranteed and may lose value.
This material is prepared by Ballentine Capital Advisors for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation or any particular security, strategy, or investment product.
No representation is being made that any account will or is likely to achieve future profits or losses similar to those shown. You should not assume that investment decisions we make in the future will be profitable or equal the investment performance of the past. Past performance does not indicate future results.
Advisory services through Ballentine Capital Advisors, Inc.
ihttps://www.golfdigest.com/story/as-golf-season-winds-down–now-s-the-time-to-address-your-lower-
ihttps://www.foodnetwork.com/recipes/food-network-kitchen/scalloped-potatoes-recipe-2011508
iiihttps://www.travelandleisure.com/travel-tips/what-not-to-pack-in-carry-on-suitcase