A systematic investment approach that tilts a portfolio toward well-documented return drivers (factors) — including value, quality, momentum, size, and low volatility — that have historically produced excess returns.
Deeper Explanation
Fama and French's research identified that market returns can be decomposed into systematic factors: the equity risk premium (market), the value factor (cheap stocks outperform expensive), and the size factor (small caps outperform large caps). Subsequent research added momentum, quality (profitability), and low volatility as additional premia. Factor investing seeks to capture these premia systematically through rules-based portfolios. The practical challenge: factors go through extended periods of underperformance (value underperformed growth from 2007 to 2020) requiring investor patience. Factors also tend to be crowded when widely followed — reducing future expected premia as more capital targets the same signals.
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