NOTIONS ABOUT FACTOR INVESTING
Factor investing refers to a framework or procedure seeking to generate the risk premia by incorporating expositions to different factors to create a portfolio. Anchored in academic research, broad factors such as momentum, quality, and volatility have exhibited its capabilities to provide a premium to a certain asset or instrument. This kind of investing has continued to gain traction in the industry. However, some fallacies have emerged. Today, let us clarify or debunk some of the misconceptions regarding this type of investing.
Factor investing is tantamount diversification. Majority of investors believe this investing is similar to putting different asset classes in a portfolio. Maybe yes. Or maybe no. We often fail to realize our portfolio is not as diversified as it appears. And we tend to forget even differing assets or securities may be exposed to the same set of risks. Using factor investing, an investor can evaluate several asset classifications and its underlying perils to ensure whether or not the holdings are well-diversified.
Factor investing is limited to stocks only. Definitely not. The most commonly used factor strategies include momentum, quality, value, and volatility. In most cases, equity smart beta strategies provide an avenue to this kind of investing. But bear in mind that the idea goes beyond stocks. Every investor aims to reach their financial goals by finding the most suitable instruments for their portfolio. That’s understandable. Good thing factor investing encompasses all types of instruments like bonds, currencies, and stocks, whether short- or long-term.
Factor investing is passively managed. Not at all. Remember factor investing is a mixture of active and passive management, enabling investors to maximize returns and minimize risks while capitalizing on the advantages of passive technique. Factor, conventional active, and conventional passive strategies can bolster a portfolio. But cheaper smart beta techniques can also render the same results.