Factor investing has become increasingly popular in recent years. However, different players in this field – academia, practitioners and investors – have different focuses. This article summarizes key perspectives on style factor investing from these three groups. From academic research on discovering new factors to real-world implementation issues considered by practitioners. And for regular investors, how to select appropriate factor ETF products. There are also core concepts explained like factor momentum vs factor value timing. With in-depth analysis synthesized from various quality sources, this guide on style factor investing provides a 360 degree view for those interested in this area.
Origins and objectives of academic factor investing research
The academic study of factors dates back to the 1930s, with Value Premium proposed by Graham and Dodd. Later CAPITAL and APT provided quantitative tools for analysis. Fama-French 3 factor model and the qmj(quality minus junk) factor are major milestones. The main goal is to develop empirical asset pricing models that best explain cross-sectional stock returns. Rigorous statistical analysis is key – GRS tests, MV spanning tests and Bayesian approaches are commonly used. With hundreds of new factors discovered, the ‘factor zoo’ issue has led to increased focus on analyzing independence, relevance and rationale of factors.
Real-world considerations for practitioners in factor investing
For practitioners, real-world investability constraints must be considered when implementing factor strategies. Factor crowding as more funds adopt similar approaches is a big concern – it hurts liquidity while reducing factor returns over time. Skilled factor timing is essential but remains debated, with pros and cons to factor momentum vs factor value timing. For funds employing factors, the key is distinguishing alpha vs factor beta. Innovation from new data sources and machine learning is viewed as vital as well.
Choices facing regular investors interested in factor ETFs
With the proliferation of smart beta ETF products, regular investors now have access to factor investing. However, selecting appropriate ETFs is challenging. One must look beyond costs and historical returns, to understand how the ETFs are constructed and which underlying factors are used. Investor education on factors is important. Innovative firms are exploring use of carbon emissions, ESG factors and other new data signals to enhance definitions of quality.
Factor investing has evolved from an academic concept to a popular real-world investment approach. But perspectives on factors still vary substantially based on one’s role. By appreciating these diverse viewpoints, from research to application to product selection, participants can make more informed choices in this field.