FACTOR INVESTING: Insights to stay ahead of the curve

 

Blog by: Ms. Kaushiki Bugde and Dr. Supriya Desai

“If you don’t find a way to make money while you sleep, you will work until you die.”

The art and science of investing are constantly evolving. Every investor is unique and has specific financial goals and requirements. Hence, investors need an investment strategy that is customized to their needs.

When you decide to buy a mutual fund, investment experts ask you to assess your risk tolerance levels, the time horizon of investing, and financial goals to choose the right funds for you. However, there are different strategies used by experts to choose investments. Today, we are going to talk about one such strategy – Factor Investing.

Factor Investing is a strategy of investing where investments are chosen based on certain factors that can help generate higher returns, increase diversification, and manage the overall risks of the investment portfolio. While factor investing has been used by experts for a long time, it is only recently that it has started gaining popularity among investors. There are two broad categories of factors that are used in this investment strategy:

Common factors used in factor investing:

While there are hundreds of factors that you can choose from, here are some of the most commonly-used factors.

➤➤ Value: When you use value as the factor, you try to find stocks that are being traded at prices lower than their fundamental values. By investing in such stocks, you can earn high returns when they increase in price to match their intrinsic values.

There are many financial ratios that can help you identify undervalued stocks including: Price to Earnings Per Share (EPS) or P/E Ratio Price to Book Value or P/B Ratio Price to Sales or P/S Ratio Price Earnings Growth Rate Ratio [PE/Annual EPS Growth Rate] Debt to Equity or D/E Ratio Debt to Asset or D/A Ratio Dividend Payout Ratio, and many more

There are many mutual fund managers that base the fund’s portfolio using the value. If you are planning to get started with Factor Investing and want to invest in

a basket of value stocks, then you can consider investing in such funds. Note that, there are various mutual funds that use factor-based investment strategies.

➤➤ Size of the company: This factor can help investors identify small-cap companies that have the potential to offer better returns than large-cap stocks.

➤➤ Quality of the company: This factor helps identify stocks of companies that have strong corporate governance, low debt, and consistent returns. Such stocks tend to outperform their peers. You can identify high quality stocks by using factors like: Return on Equity or ROE Ratio Earnings Stability Dividend growth stability Cash flows, and many more

➤➤ Momentum: This is an important factor as it allows investors to choose stocks that have witnessed strong growth in recent quarters. While the reasons behind the growth may vary, some investors look for stocks that have momentum on their side and invest in them.

➤➤ Volatility: Some investors believe that stocks with low volatility can earn higher risk-adjusted returns than those with higher volatility. They choose stocks based on the volatility in their prices.

➤➤ Dividend Yield: This factor can help you identify stocks that have a higher dividend yield than the sector average. Many investors believe that such stocks tend to outperform stocks with lower yields in the long run.

➤➤Active and Passive investing: Active and Passive investing are investing techniques used by investors and fund managers across the world. In active investing, you choose stocks and mutual funds based on your research and analysis. You monitor your investments and buy/sell them based on their performance. In passive investing, you invest in an index fund or a set of securities where you try to benefit from the growth of the said set.

When one understands the factors to be considered for factor investing and employ the strategies best suited for them, they can earn exceptional returns. To summarize, factor investing is a simple yet beneficial concept for financial market traders. It helps gain the necessary knowledge required to assess the returns over risks for an investment strategy.

Ms. Kaushiki Bugde

Mail- Kaushiki.Bugde@indiragbs.edu.in

Dr. Supriya Desai

Mail- supriya.desai@indiragbs.edu.in