The Factors


What are Factors in an Investment setting, OR What are Factors?

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.

Factors in an Investment

We all praise Sachin's text-book style square cuts and master strokes… but, is he enough to win most matches for the Indian cricket team??

Apart from Sachin's quality batting, we also need Dhoni's captain-cool low-volatility advice, Sehwag's strong scoring momentum, and Dravid's valuable "wall" for a victory.

Similarly, when buying a new property, we would generally not make a decision solely based on the property’s price, but also look at its location, safety and amenities among other aspects. Likewise, when making investment decisions, professionals tend to evaluate securities based on various parameters viz. prices, volatility, relative value, earnings, interest rates, growth, and liquidity among others. These different elements help explain the risks and returns of financial securities and are referred to as factors in the context of investing.

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