Investors seeking to diversify a traditional equity portfolio may consider market factors and the effects of combining various factors into a multi-factor strategy.

On the recent webcast (available On Demand for CE Credit), How to Use Single- and Multi-Factor Strategies in Every Portfolio, Mo Haghbin, Head of Product, Beta Solutions at OppenheimerFunds, highlighted the shift in the marketplace, outlining the current increase in volatility driven by a confluence of monetary tightening, a higher inflationary trend, and the introduction of tariffs.

Consequently, investors could look to alternative investment strategies like factor-based investments to help smooth out a bumpy ride. Greg Ellston, Director of Asset Allocation at Confluence Investment Management, also added that the nascent inflationary pressures triggered by more restrictive trade policies could foreshadow greater influence on equity valuations and on factor exposures.

To help investors better understand factor investments, Haghbin defined factors as something can be thought of as any characteristic relating to a group of securities that is important in explaining their return and risk. Factors have historically shown to provide favorable risk-adjusted returns over long periods, or above the returns of the broader market.

“Factor investing is based on the idea that there are various sources of risk that investors are compensated for over time, and investors can harness these factors in a portfolio to potentially generate higher returns, reduce risk, and enhance diversification,” Haghbin said.

To determine if a factor is more than a statistical anomaly and can be relied upon to generate additional returns over time, an investor can evaluate a factor by considering whether or not it holds over time; holds across countries, regions, sectors; holds for various definitions; has a logical explanation for its premium; and shows results after implementation.

The most common market factors include low volatility, momentum, value, quality, size and yield. These various factors have exhibited specific characteristics that allowed them to outperform their peers. For example, low volatility include stocks that exhibit lower volatility tend to perform better than stocks with higher volatility. Momentum refers to stocks that rise or fall in price tend to continue rising or falling. Value covers stocks that appear cheap tend to perform better than stocks that appear expensive. Quality or higher quality companies tend to perform better than lower quality companies. Size or smaller companies tend to perform better than larger companies. Lastly, yield or higher yielding stocks tend to perform better than stocks with lower yields.

As an investor fills out a diversified portfolio with factor exposures, Joe Smith, Senior Market Strategist for CLS Investments, explained that CLS based their decisions on a target level of risk desired, allocating to factors they strategically believe are beneficial to portfolios over the long-term while constantly measuring and evaluating exposure to these factors.

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