Ever since the first stocks and bonds started trading, investors have tried to understand what drives returns. By the 1930s, academics and practitioners started systematically identifying broad and persistent drivers of return, which later took on the name of "factors."
Factors enable investors to pursue outcomes that might be different than "the market" – like seeking outperformance or reduced risk. Quality, momentum, value and size are factors that have shown the potential to deliver return premiums beyond what the market offers. But outperformance tends to be cyclical, making it more challenging to seek consistent returns.
What's a factor investor to do? Cyclicality is unavoidable; bearing short-term underperformance is often a requisite for earning a long-term premium. Our latest commentary shares two possible approaches for investors wishing to benefit from the potential results of factor investing:
1Multifactor for the long term — Investors with a lower tolerance for risk can consider a turnkey solution that is diversified across multiple factors. As a result, when one strategy underperforms, another might pay off. Multifactor portfolios may also benefit from a rebalancing bonus. Because they are periodically rebalanced back to targeted factor weights, they provide a simple and powerful mechanism that seeks to buy low and sell high.
2Single factor for the short term — Investors with a higher risk tolerance, a shorter time horizon and special insights and views can consider employing factor tilting to pursue incremental return. At BlackRock, we have observed that key indicators such as the business cycle, valuations, relative strength and dispersion may contribute to forward-looking performance of individual factors.
As with most things in life, however, factor investing doesn't have to be black and white. Many investors take an approach that embraces both the long- and short-term potential of factors: They maintain a diversified multifactor strategy at the core of their portfolio, and make modest factor tilts around that core.
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