By Yazann Romahi, Joe Staines & Garrett Norman via Iris.xyz
The rise of factor investing has sparked excitement as well as angst across the investment community. As these strategies have become increasingly popular, investor enthusiasm has been coupled with questioning as market participants look to understand how the dynamics of factor investing might change over time.
Among the questions investors are asking:
- As investors crowd into factors, will returns persist, or will they decrease over time?
- Can we time factors?
- How might the dynamics of factor investing change in the coming years?
We begin with a few basics. We define a factor as any characteristic that describes the risk of a group of securities or financial instruments. Exposure to a factor based on an economic rationale should reward (or compensate) an investor (Exhibit 1). Compensated factors fall into three overlapping categories: risk-based (such as size, merger arbitrage) behavior-based (momentum, quality) and structural-based (low volatility, index arbitrage).
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