Almost any parameter associated with the fundamental or market data of a company can be used as a factor. With potentially hundreds of factors available it is necessary to choose the most effective ones and avoid those that may be construed as random noises or one-time anomalies. Empirical developments in this space demonstrate that commonly accepted investment factors explain security returns cross-sectionally, over time, and across markets.

Common Attributes of Investment Factors

Any determinant of investment returns and/or risk must adhere to 5 unique attributes in order to be formally classified as an investment factor (Berkin & Swedroe, 2016). Investment factors must be,

• Persistent - The parameter must consistently explain returns over time i.e. its explanatory power must not fade away over time.

• Pervasive - The parameter must explain returns across markets, economies, sectors, and geographies.

• Robust - The parameter must not change its meaning or impact significantly with changes in the definition of its characteristics. For example, whether defined as the trailing price-to-earnings, price-to-book, or dividend yield, the meaning and economic significance of the Value factor must remain truly unambiguous.

• Investable - Gaining exposure to the specific parameter must be easy and cost-efficient.

• Intuitive - There must be an economic rationale/justification for getting exposure to that specific parameter.

Factor Categories: Macroeconomic Vs Style

Most investors classify investment factors into two broad categories, namely macroeconomic and style factors. As its name suggests, macroeconomic factors illustrate broad macroeconomic and financial elements of risk across several asset classes such as equities, fixed income, and gold. Common macroeconomic factors include interest rates, real GDP/economic growth, inflation, money supply and liquidity. Macroeconomic factors are typically used to determine asset allocation between different asset classes.

On the other hand, style factors are those specific to an asset class and used to select securities within the asset class. The most prevalent style factors for equities include size, quality, volatility, value, and momentum. We explore these in detail in the coming sections.