Stand United or Divide and Conquer? What is the Best Approach to Factor Investing?
There are pros and cons to the various approaches to factor investing. We believe that investor interests are best served through a multifactor investing process.
Factors such as Value, Size, Momentum, Quality or Volatility are employed to identify stocks with specific characteristics. Such stocks are then used as part of an investment strategy to generate potential returns above a specific benchmark. For instance, stocks that exhibit lower volatility are thought to provide higher risk-adjusted returns to investors due to behavioral effects. Similarly, Value stocks are understood to be cheaper relative to their intrinsic value, and eventually provide higher returns when this intrinsic value is realized. As far as the factor investing process is concerned, single-factor exposure and factor-timing processes are among the most popular approaches. We analyze the pros and cons of both of these approaches and suggest that a multifactor bottom-up blending process combines the benefits of both and offers the best risk-adjusted returns.