Market factors have existed for as long as markets. The impact of factors often went unnoticed and in earlier years, was frequently misinterpreted as being the stock picking skill of the manager – this is usually called the Alpha.

Factor investing is a particular method of investing that is primarily focussed on gaining exposure to very defined market factors. Market factors are fundamental characteristics that investors try to gain exposure to with the aim of achieving higher returns. Examples are investors buying stocks that provide high dividend yields – the income factor; or buying stocks that have performed well in the recent past – the momentum factor. There is also a Quality Factor and a Minimum Volatility Factor. Nobel Prize winner Eugene Fama and Kenneth French identified both the Value Factor and Size Factor in the 1990’s. Mark Carhart is credited with subsequently discovering the Momentum Factor.

It is only in the past 10 years that factors have become a mainstream concept. It is an inconvenient truth for some, that much of what we believed previously was a stock picking skill, is only compensation for bearing more risk or gaining exposure to the idiosyncrasies of the market.

The concept of factor risk premia [the increased return you can expect from gaining exposure to these factors] has existed for decades. The refinement of factors into a fund that is suitable for the general public to invest in is a relatively new concept. Many of the exchange traded funds [ETFs] who provide exposure to these factors only became available in the past 10 years. Using these ETFs, investors can gain exposure to a diversified range of equity returns at, potentially, low cost.

The systematic approach used by Funds is designed to try to harvest the risk premia, while also seeking to avoid some of the common pitfalls associated with investing. Those pitfalls are basically human irrationality and behavioural biases – buying high and selling low. Having exposure to different factors ensures that no single factor dominates the portfolio.