"We dont have to be smarter than the rest. We have to be more disciplined than the rest." - Warren Buffett
"You have to learn the rules of the game, and then you have to play better than anyone else." - Albert Einstein
One might think of factors as features that one considers before making a purchase. Price, location, amenities, and safety are all common considerations when purchasing real estate. Similar to how consumers evaluate products, factor-based investors typically assess securities based on a number of characteristics (such as Quality, Value, Low Volatility, and Momentum), which are known as "Factors" in the investing world. Factor investing is the practice of making investment decisions, such as stock selection and asset allocation, solely on the basis of quantitative principles to gain exposure to certain factors.
Investing in factors: Active or Passive?
By copying the underlying stocks and their weights, passive investing aims to replicate a benchmark index (such as the Sensex 30 or the Nifty 50). Although it cannot outperform its underlying index, it does have the advantage of being intrinsically disciplined. Conventional active investing is, in contrast, mostly discretionary as fund managers select which stocks to buy. They offer the chance to outperform their benchmark index, but investment choices aren't governed by strict rules.
Factor investing combines the best qualities of both passive and active investment strategies by using rules to find stocks with desirable characteristics and build a portfolio that has the potential to outperform the benchmark index.