Investing is a bit like being lost in a maze. Most new investors have heard of alpha and beta. Alpha represents the excess return an investment generates over a benchmark. Beta reflects how much an investment's price moves with the market. Those are useful indicators, but certainly not a complete story. Factors-based investing presents a picture of how to return better? This article investigates the role of factors-based investment opportunities.

Understanding Factor-Based Investing

Factors-based investing identifies and targets specific characteristics that drive returns. In other words, these factors help explain why some investments outperform others over time. Style and macroeconomic factors are broad categories.

• Style Factors

Style factors consider specific types of characteristics in stocks. The most important style factors are:

• Value: Undervalued stocks vis-a-vis their fundamentals.
• Growth: Companies projected to grow faster than the market average.
• Momentum: Stocks that have shown high performance in the recent past.

Studies by Morningstar point out the fact that value stocks outsourced growth stocks at an annual rate of about 4% over a period of 15 years. This demonstrates the possible benefits of moving in with style factors.

• Macroeconomic Factors

Macroeconomic factors are a broader set of economic variables. Some of the most key ones include interest rates, inflation, and growth. For instance, a J.P. Morgan study concluded that utility stocks average about 10% during rising interest rates periods. In contrast, the S&P 500 averaged a paltry 7%. A good investment strategy depends on comprehension of these macroeconomic factors.

Benefits of Factors-Based Investing

Factors-based investing has various advantages. Some of them are as follows:

• Improvement in Risk management: It delivers better returns than market-based investing for similar sorts of risks. Adding factors to your investment strategy will help control the risk you are exposed to. Each factor performs best at different times in the market. Low-volatility stocks, for example, tend to shine when markets fall. In 2008, the lowest that the year went was in the financial crisis, MSCI reported that low-volatility stocks outperformed high-volatility stocks by 7%. This proves that how you pick specific factors helps in managing risk.
• Better Diversification: Factors provide better diversification. Instead of relying on one kind of asset, investors can distribute their investments over various factors. A diversified portfolio can eliminate the risk of large losses. According to Vanguard, a diversified portfolio that is spread over factors has 30 percent less volatility within time. This implies stability when the market fluctuates.
• Better Returns: Factors may contribute to more excellent returns. Combining several factors can also realize a stronger general performance. A BlackRock study of 2021 demonstrated that a portfolio combining value and momentum factors realized an average annual return of 12%. In contrast, the return for the S&P 500 was 9% of the same period. By such means, one can capitalize on using several factors in order to enhance investment results.

Practical Strategies for Factors-Based Investing

Investors may express factors-based strategies by various means such as:

• Factor-Based Exchange Traded Funds (ETFs): One of the easiest ways to get exposure to factors is through exchange-traded funds. Many funds target specific factors. For example, the Invesco S&P 500 Pure Value ETF (RPV) invests in value stocks. For the past five years, this fund has returned around 11% annually, while the S&P 500 managed to return around 10% annually over the same period. ETFs make it very easy to invest based on factors.
• Customized Factor Portfolios: Alternatively, customized factor portfolios may be constructed on a combination of factors. You can combine value, growth, and momentum to create a diversified investment strategy. Research has shown that a multi-factor portfolio can generate 15% more value over a 20-year period compared to a single-factor portfolio. Such evidence illustrates the benefit of diversification for factors.
• Tracking Economic Indicators: On the economic indicator front, you can also track those indicators to optimize factor exposure. In inflationary conditions, for instance, you may invest more in commodities or real estate. It is said that with inflation running high, commodities give an average return of 15%. Traditionally, stocks lag behind during such times. Therefore, such indicators keep you in close touch with investment decisions and choose the right ones.

Final Thoughts: Factor-Based Choice and Investment Landscape

Factor-based investing is much beyond mere alpha and beta consideration. Since it's factors-based, the complete understanding of the performance of an investment is allowed to be accessed. Because it bases its approach on style and macroeconomic factors, that is when more investors become aware.

Better risk management and better diversification show how great it can be. Over time, you see that returns grow much better. Factor-based ETFs or customized portfolios are a great choice to bring your approach to investing into a higher level. It would make you better prepared for the investment landscape by focusing on these elements. Factors-based investing does not just enlighten people but also puts them in a position to prosper while navigating the complexities of markets.

（Writer：Haicy）