Foundations of factor investing

Following on from our series on factor investing, by Jason Swartz of Satrix, we received these definitions of the different types of factors that investors can choose to apply in their portfolios:

Value: Value aims to capture excess returns from stocks that have low prices relative to their fundamental value. This is commonly tracked by price to book, price to earnings, dividends and free cash flow.

Size: Historically, portfolios consisting of small-cap stocks exhibit greater returns than portfolios with just large-cap stocks. Investors can capture size by looking at the market capitalisation of a stock.

Momentum: Stocks that have outperformed in the past tend to exhibit strong returns going forward. A momentum strategy is grounded in relative returns from three months to a one-year time frame.

Quality: Quality is defined by low debt, stable earning, consistent asset growth, and strong corporate governance. Investors can identify quality stocks by using common financial metrics like return to equity, debt to equity and earnings variability.

Volatility: Empirical research suggests that stocks with low volatility earn greater risk-adjusted returns than highly volatile assets. Measuring standard deviation from a one- to three-year time frame is a common method of capturing beta.

With thanks to Alban Atkinson of Ince, who passed these definitions on to us.