Vantage Point: Achieving Diversification

Factor investing: what is momentum and how can it be applied?

Describe how momentum and sustainability factors work in principle
Explain how malfunctioning of the stock market helps momentum investing
Identify how sustainability works as a factor in investing

CPD

Approx.30min

In summary, factor investing is an investment approach that involves targeting quantifiable factors that can explain differences in security returns. Momentum is the one of the five most widely accepted factors, with its focus on securities that have performed well over recent time periods.

A sustainable investing approach can be used as an additional lens through which a factor-based strategy can be deployed, and there are currently significant developments occurring in the regulatory regime around sustainable investing in the UK, through the FCA’s SDR and investment labels regime.

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This article concludes the wider series covering factor investing. If you are looking for a book on the subject of factor investing then Your Complete Guide to Factor-Based Investing by industry pioneers Andrew Berkin and Larry Swedroe is a great place to start. We wish you all the best in your factor investing journey.

Factor investing is an investment approach that involves targeting quantifiable characteristics or ‘factors’ that can explain differences in security returns.

Factors are a set of properties common to a broad set of securities, and a factor-based strategy will typically approach these in a systematic and rules-based manner.

To be worthy of exposure, a factor should meet a number of criteria:

Persistent – the factor works across long periods of time and different economic regimes.
Pervasive – the factor works across different countries, regions, sectors, and even asset classes.
Robust – the factor works across different definitions of itself.
Investable – the factor works not just on paper, but also after considering implementation issues.
Intuitive – there should be logical risk-based or behavioural-based explanations for the factor.

Academics and practitioners have broadly coalesced around the following set of five widely accepted factors:

Value – securities with lower prices relative to their fundamental value.
Size – securities with lower market capitalisation.
Momentum – securities that have outperformed in recent time periods.
Minimum volatility – securities that demonstrate lower volatility.
Quality – securities that demonstrate higher profitability and resilience.

A factor-based investment strategy will tilt a portfolio towards or away from specific factors, seeking to harness favourable characteristics in order to generate additional return, or reduce risk, in comparison to the wider market.

Sustainability is not typically classified as a factor in and of itself, and instead it can be seen as an additional lens through which a factor-based strategy can be deployed.

Jonathan Griffiths is an investment product manager at EBI Portfolios

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Factor investing: what is momentum and how can it be applied?

The momentum factor is the tendency for assets that have performed well in the recent past to stop performing in the near future, true or false?

The momentum factor itself is typically seen as:

A market 'under-reaction' to a stock is when:

ESG inclusion is the exclusion of specific stocks in a strategy, true or false?

Which of the following is NOT a label of sustainability categorisation from the FCA?

When does the labelling regime come into effect?

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