FACTOR INVESTING EXPLAINED

Arrows to the right
Arrows to the right

Global markets are made up of dozens of asset classes and millions of individual securities, making it challenging to understand what really matters for your portfolio. But there are a few important drivers that can help explain returns across asset classes – these are known as Factors.

Factor style investing, has become prominent in recent years as investors seek to enhance portfolio returns and diversification while keeping volatility low. Factor investing is the strategy of targeting securities with specific characteristics such as value, quality, momentum, size, and minimum volatility.

These characteristics are persistent and well-documented and have generated returns due to the following three reasons: an investor’s willingness to take on risk, structural impediments, and the fact that not all investors are perfectly rational all the time.1

Factors are not new — they have been present in portfolios for decades. But exchange traded funds (ETFs) have helped to revolutionise how investors access these historically rewarded strategies2 by capturing the power of factors in a transparent and cost-effective way.

WHAT ARE THE FACTORS?

As mentioned above there are five factors that have historically proven to be drivers of return, and iShares offers ETFs that seek to capture all five:
Caption:

Comparison table showing the five factors utilized in iShares Factor ETFs. Each row shows a different factor (value, quality, momentum, size, minimum volatility), as well as its primary objective.
FactorObjective
ValueInvests in stocks that are lower cost relative to their peers. Think of value investing as going bargain shopping at the mall. If you’re indifferent between two pairs of shoes at different price points, for example, you should buy the cheaper of the two. It’s a similar concept for stocks.
QualityInvests in companies with strong financials relative to similar cost peers. That means that we’re looking for stocks that are profitable, have low leverage, and demonstrate consistent earnings over time.
MomentumInvests in stocks that are outperforming and reduce exposure to stocks that are underperforming. Momentum strategies evaluate stocks based on how well they have performed over the recent past, such as the trailing 6 or 12 months.
SizeInvest in smaller, and more nimble companies. While they may have fewer resources than larger competitors, smaller companies may be more nimble, and can potentially more easily adjust and identify new investment opportunities.
Minimum VolatilityInvest in stocks that collectively have lower volatility than the broad market. Unlike the other four factors, the goal of minimum volatility is not necessarily to enhance return, but to reduce overall risk.
Video 02:40

Factor investing

Many of the traits that active managers have looked for (like buying under-priced or quality stocks) are called factors.

 

Now, you can use ETFs to invest in stocks that exhibit the Factors that have historically driven portfolio returns.

Understanding how factors work can help you capture their potential for excess return and reduced risk. Given the Factors are driven by different phenomenon, they are generally lowly correlated,3 and performance tends to vary in certain market regimes. The performance of various Factors over the past market cycle shows why a dynamic approach to Factor allocation matters.
Where factors perform during economic cycle

Source: BlackRock 2023. For illustrative purpose only.

HOW DO FACTOR ETFs FIT IN A PORTFOLIO?

With Factor ETFs, investors can get cost-effective access to systematic sources of higher potential expected returns. And they can do so in a way that helps them reduce the guesswork. You don’t have to go stock by stock.

The diagram below shows how Factors play a critical role in meeting the return demands of a typical investor while keeping a lid on cost.
Triangle indicating different types of investment goals and solutions

At BlackRock, we advocate an ‘equity pyramid’ approach to portfolio building. This pyramid combines index investing, which provides broad market exposure at low-cost, with Factors that have persistently outperformed4 or reduce portfolio risk.5 On top of this, deploying capital through active managers gives an investor access to Alpha-seeking strategies which have consistently beaten markets.

iSHARES FACTOR ETF RANGE

Invest in resilient companies with healthy balance sheets.

Invest in resilient companies

Get value from your investment.

featured funds

Riding on momentum.

riding on momentum

Find resilient stocks in times of uncertainty.

Find resilient stocks

Look for size in key markets.

All the factors in one single trade.

All the factors in one single trade

WHY FACTOR ETFs?

Chart icon

Outperformance potential

Factors are long term drivers of historical returns. Factor ETFs allow investors to express their market views or convictions with ease. For example, momentum exposures could benefit from economic upswings and value exposures may benefit from when markets are expected to rally.
Protect shield icon

Managing risk

Factor ETFs can help to manage some risk and reduce volatility within an investment portfolio through constraints placed on sectors and geographies - meaning investors are not overexposed. For example, an investor with an overweight technology exposure may look to add a value ETF to their portfolio to help diversity.
Low volatility icon

Tactical asset allocation

All investment portfolios are exposed to factors regardless of whether they have a concerted tilt. Understanding the portfolio exposure can assist with tactical allocations by linking factor styles to moments in the market cycle. For example, during periods of high inflation, companies with higher quality earning may be worth considering.