Attributes of Investment Factors

Almost any parameter associated with the fundamental or market data of a company can be used as an investment factor.

With potentially hundreds of ‘factors’ available it is important to distinguish between elements that persistently explain securities’ risks and returns from those that may be construed as random noises or one-time anomalies. For instance, the COVID-19 pandemic can be considered as an important determinant of securities’ returns in the recent past, however, in order to classify COVID-19 as an investment factor, it must persistently explain securities’ returns over long periods of time.

Empirical developments in this space have demonstrated that commonly accepted investment factors explain security returns cross-sectionally, over time, across markets and through various economic cycles.

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), namely:

  • 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.
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