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What is factor investing?
Put simply, factor investing refers to allocating to certain investment styles (or factors), with the main ones illustrated below. Such factors have historically generated excess returns over the long term, attributed to a combination of structural, behavioural and risk-based explanations. Also known as ‘smart beta’ or ‘alternative risk premia’, these different factors have informed the evolution of how we classify and attribute performance and risk in portfolios, particularly the balance between active managers’ skill (alpha) and broad market exposure (beta).
Factor types
Some of the factors, such as ‘value’ or ‘quality’, will probably be familiar to investors as popular investment styles in equity investing. The following are the most common equity factors that investors focus on:
Value
Stocks that are undervalued relative to the market or peers based on company fundamentals.
Low volatility
Stocks with lower historical volatility relative to the market or peers.
Quality
Stocks with higher profitability and/or less aggressive asset growth relative to the market or peers.
Momentum
Stocks with a positive share-price trend.
Factors and economic seasons
One feature of factors is that they can be expected to perform best during particular phases of the business or economic cycle. We can think about these phases like the seasons of the year:
Reasons to invest
Through factor investing, investors can start with the objectives they seek to achieve and work backwards to create a portfolio that aims to meet those objectives.
This approach is thus more than just a single index or fund: it is a way of investing that can be used for achieving specific investment objectives. Some of these objectives include the potential for:
- Return enhancement
- Risk reduction
- Income generation
- Diversification
The rising popularity of index-based investment strategies has been a clear feature of the institutional investment landscape in recent years. Comparatively low transaction costs, ongoing charges and governance costs are often cited by investors as advantages of using index funds.
Why LGIM for factor investing?
We have deep expertise across factor investing, index customisation and ESG strategies. Our factor investing offering is built upon four pillars:
1.Ability to customise to meet clients’ needs:
Our Index Solutions team can build bespoke indices to meet specific investment objectives
2.Our sustainability credentials:
LGIM has been a leading responsible investor since it was established in 1971
3. Transparency:
Our factor framework aims to give investors visibility of underlying risk and return drivers while also integrating our proprietary ESG assessment
4. Links to investor practices:
We have designed factors in a way that integrates practical investment thinking into the process
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Fadi Zaher
Head of Index Solutions
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Key risks
The value of any investment and any income taken from it is not guaranteed and can go down as well as up, and investors may get back less than the amount originally invested. The risks associated with each fund or investment strategy should be read and understood before making any investment decisions. It should be noted that diversification is no guarantee against a loss in a declining market. Further information on the risks of investing is available from LGIM’s Fund Centres.
While LGIM has integrated Environmental, Social, and Governance (ESG) considerations into its investment decision-making and stewardship practices, this does not guarantee the achievement of responsible investing goals within funds that do not include specific ESG goals within their objectives.