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What is factor investing?

Factor investing is an investment approach that involves targeting specific drivers of return across asset classes. There are two main types of factors: macroeconomic and style. Investing in factors can help improve portfolio outcomes, reduce volatility and enhance diversification.

Learn more about the philosophy behind factor-based investment strategies and how factors can strengthen your portfolio.

 


Introduction to factors

Factors are the foundation of investing—broad, persistent drivers of returns across asset classes. Understand how factors work to better capture their potential for excess return and reduced risk, just as leading investors have done for decades.

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    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 FACTORS are broad, persistent drivers of return that are critical to helping investors seek a range of goals from generating returns, reducing risk, to improving diversification.

    Today, new technologies and expanding data sources are allowing investors to access factors with ease.

    Factors are the foundation of investing, just as nutrients are the foundations of the food we eat. We need carbohydrates and protein to power through the day, which we can find in different foods like bread, milk, and fruit. Putting together a balanced diet means understanding what nutrients are contained in our food, and choosing the mix that best supports our body’s needs.

    Similarly, knowing the factors that drive returns in your portfolio can help you to choose the right mix of assets and strategies for your needs.

    There are two main types of factors that drive returns. Macro factors like the pace of economic growth and the rate of inflation can help to explain returns across asset classes like equity or bond markets.

    Style factors can help explain returns within those asset classes. For example, Value stocks – those that have low prices relative to fundamentals – have historically generated returns greater than the broad market.

    Factors can help us build portfolios that better suit individual needs; just as knowing the nutrients in your food can help your body perform. Similarly, investors looking for downside protection in a volatile market environment might add exposure to minimum volatility strategies to seek reduced risk, while Investors who are comfortable accepting increased risk might look to more return-seeking strategies like momentum.

    Now – why do factors work? Extensive research, including that of Nobel prize winners, has proven that certain factors have driven returns for decades. These factors 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.

    Some factors earn additional returns because they involve bearing additional risk, and may underperform in certain market regimes.

    Some factors arise from structural impediments, those investment restrictions or market rules that make certain investments off-limits for some investors, creating opportunities for others who can invest without those constraints.

    And finally, some factors capture investor behavior, that is, actions of the average investor that are not always perfectly rational. Sometimes people want French fries instead of salad even if they are watching their cholesterol. These behavioral biases can give rise to investment opportunities for those who can take on a contrarian view.

    Let’s discuss ways to access factors. Advancements in technology and data allow investors to take advantage of these time-tested ideas in new ways, from smart beta to enhanced factor strategies.

    Smart beta strategies target factors using a rules-based approach, usually with the goal of outperforming a market-cap weighted benchmark. Smart beta strategies are now widely available in ETFs and mutual funds, making factor strategies affordable and accessible to every investor.

    Enhanced strategies use factors in more advanced ways - trading across multiple asset classes, sometimes investing both long and short. Investors use these enhanced factor strategies to seek absolute returns or to complement hedge fund and traditional active strategies.

    Factors can help to power your investments and can help to achieve your goals.

    BlackRock is a leader in factor investing, launching the first factor fund in 1971 and driving innovation in the category for over 40 years.

Andrew Ang meets with visionaries across a range of industries to define the factors that have led to their extraordinary results. Each conversation offers unexpected perspectives, philosophies, and insights that have driven their success.

See more of Andrew’s conversation with Danny Meyer See more of Andrew’s conversation with Danny Meyer
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    Every successful endeavor is built on common-sense principles, layered with ingenuity and imagination. I’m looking to uncover the basic building blocks that are the factors of expertise in every field.

    I’m Andrew Ang, Head of Factor Investing at BlackRock. This is Defining Factors.

    Today, I’m with renowned restaurateur and food industry icon, Danny Meyer, to learn about the defining factors of success from ventures like Shake Shack, and his latest restaurant, located 60 stories above New York City, Manhatta.

    Andrew: We all know that a restaurant has a chef and a chef has a recipe, but what’s the recipe for the entire restaurant?

    Danny: Well, the good news is there’s 49 parts performance. How good did the food taste? How was the timing? Was the lighting right? Was the sound right?

    Danny: So, it’s 49 parts performance and our recipe states that there’s 51 parts hospitality. It’s those things that make you feel that we’re being thoughtful, that we were combining our thinking and our feeling to do things for you.

    Andrew: Hospitality to your restaurants, I think it’s very similar to factors for my investments.

    Danny: As an investor, if I didn't know what a factor was, how would you explain that in the simplest terms?

    Andrew: Factors are drivers of return. Like value, momentum, quality. We can look at cheap stocks. Smaller stocks. Stocks that are trending. Stocks with high quality earnings, we put them together in different ways to create the objectives that we want.

    Danny: Therefore, I’m not simply looking at this company and this stock, I'm looking at this company and stock within a much broader context and now I can understand it.

    Andrew: And whether that’s for your whole portfolio to meet your financial goals, to aim for financial well-being, to understand why you’re investing. We look at the factors to deliver that experience. But we need to constantly think about new ways of delivering that experience to our clients. I want to make these investment ideas accessible to the everyday person.

    Danny: Well, I’ve always loved taking that approach, starting with my first restaurant, Union Square Café, where we were trying to do a refined version of a highly accessible neighborhood café.

    Andrew: We’re always going to have restaurants, but the type of restaurant has to evolve. And, our diners and clients are the better for that. And that’s the same with factor investing. We want to refine those very familiar investment ideas, and we want to deliver them for the 21st century.

    Danny: And I think those are the ideas that are gonna play the best and the loudest in this economy.

    To learn more about factor investing, go to BlackRock dot com slash factors.

Visualize factors in portfolios

Discover how to implement factors in your own portfolio with our interactive tools.

Understand and compare the factor exposures of various funds, and to aid in portfolio construction and risk management.
See how factors have performed through economic cycles, market shocks and other time periods.

Explore factor-based strategies

The factor industry is estimated at $1.9 trillion and is projected to grow to $3.4 trillion by 2022.

Factor industry estimation

Source: BlackRock, Simfund for mutual fund data, BlackRock for ETF data, eVestment and Preqin for institutional and alternative data. Mutual fund and ETF data as of 12/31/17, eVestment and Preqin as of 9/30/17. Excludes fund of funds. Projections exclude the impact of beta.

BlackRock offers a range of solutions designed to tap into the potential of factors – from low-cost, efficient factor ETFs to smart beta target date funds to dynamically managed enhanced factor strategies.

Consider these three investment ideas to help drive your goals:

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Don’t pay active fees for
factor-based returns

Modernize your approach to the traditional style box and use factors to target specific sources of return.

Seek market-like exposure
with below-market risk

Don’t let market volatility get in the way of achieving long-term investment outcomes. Consider minimum volatility strategies to manage risk while also participating in the market.

Pursue portfolio resilience and enhanced returns with a multi-asset approach

Investors can access factors in more advanced ways across multiple asset classes and long-short strategies.

Performance data represents past performance and does not guarantee future results. Investment return and principal value will fluctuate with market conditions and may be lower or higher when you sell your shares. Current performance may differ from the performance shown. For standardized performance and most recent month-end performance click on the fund names above.

 


Read our views on factors

Stay up to date on the latest research and insights from BlackRock’s factor investing professionals.

Andrew’s Angle: Defining Factors
In my new series, Defining Factors, acclaimed restauranteur Danny Meyer shares his factors for success in his restaurants.
Read more Read more

More about factor investing

Types of factors

There are two main types of factors that have driven returns: macroeconomic factors, which capture broad risks across asset classes; and style factors, which help to explain returns and risk within asset classes.

Hover over each factor to learn more.

 

Factor Investing: Outer image
Factor Investing: Inner image

VALUE

Stocks discounted relative to their fundamentals

ECONOMIC GROWTH

Exposure to the business cycle

MINIMUM VOLATILITY

Stable, lower-risk stocks

MOMENTUM

Stocks with upward price trends

QUALITY

Financially healthy companies

SIZE

Smaller, high-growth companies

CARRY

Income incentive to hold riskier securities

REAL RATES

The risk of interest-rate movements

INFLATION

Exposure to changes in prices

CREDIT

Default risk from lending to companies

EMERGING MARKETS

Political and sovereign risks

LIQUIDITY

Holding illiquid assets

Value
Momentum
Minimum Volatility
Quality
Size
Carry
Economic Growth
Real Rates
Inflation
Credit
Emerging Markets
Liquidity
STYLE
Value
VALUE
Stocks discounted relative to their fundamentals
Momentum
MOMENTUM
Stocks with upward price trends
Quality
QUALITY
Financially healthy companies
Minimum Volatility
MINIMUM VOLATILITY
Stable, lower-risk stocks
Size
SIZE
Smaller, high-growth companies
Carry
CARRY
Income incentive to hold riskier securities
MACROECONOMIC
Economic Growth
ECONOMIC GROWTH
Exposure to the business cycle
Real Rates
REAL RATES
The risk of interest-rate movements
Inflation
INFLATION
Exposure to changes in prices
Credit
CREDIT
Default risk from lending to companies
Emerging Markets
EMERGING MARKETS
Political and sovereign risks
Liquidity
LIQUIDITY
Holding illiquid assets

Factors have generally had low correlations with each other and therefore tended to perform well at different parts of the economic cycle. Use our interactive tool to see how different factors have performed through market shocks, expansions and contractions over the long term.

Why invest in factors?

Institutional investors and active managers have been using factors to manage portfolios for decades. Today, data and technology have democratized factor investing to give all investors access to these historically persistent drivers of return.

What’s the difference between factor investing and smart beta?

Smart beta is one subset of factor investing. Factor investing harnesses the power of broad and persistent drivers of return. Factor investing can refer to macro factors (which affect returns across asset classes) as well as style factors (which affect returns within asset classes) and can be implemented with or without leverage. Smart beta strategies generally refer to style factors within a single asset class, implemented without leverage, most commonly in style factor strategies that are long only and index based, most commonly in an ETF.

What are the risks associated with
factor investing?

When it comes to factor-based strategies, investors have a lot of options. Each strategy is constructed in a unique way and may have different risks. It’s important that investors understand underlying exposures in the context of the outcome you wish to achieve. Investors who choose long-short factor strategies will add risks associated with leverage.

What are some of the myths associated with factor-based investing?

One of the most pervasive myths around factor investing is that it must be used instead of indexed or active investments. Factor-based strategies, including Factor ETFs, can be used both to replace and to complement traditional index or active investments in the portfolio.

Important consideration

As with any investment, there's no guarantee of performance. Individual factors have tended to perform well at different parts of the economic cycle, and may be less correlated with equity market moves. Be aware of this aspect of factor investing as you investigate whether any particular strategy makes sense with your investment goals. A multi-factor investment is diversified across factors and may help to reduce the effect of this cyclicality.

Why choose BlackRock for
factor investing?

BlackRock has been at the forefront of factor-based investing for decades and continues to innovate new strategies to help address clients’ investment challenges. BlackRock offers a variety of ways to implement the time-tested principles of factor investing. These range from Factor ETFs and target date funds, which offer low-cost, efficient access to factors, to multi-asset, multi-factor strategies, that incorporate BlackRock's active insights, invest across asset classes and employ leverage and shorting.

You can also tap into BlackRock's deep experience with investment factors via insights provided by our factor experts (such as Andrew Ang and Sara Shores) and online resources and tools designed for investors seeking access to factor investing opportunities.

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