Factor investing has been around for nearly three decades, but in recent years many advisors and investment companies have embraced it with a new intensity.

Underlying the uptick in interest is a growing belief that factor investing, when used correctly, can generate superior returns for client portfolios. That’s the view of Mark Balasa, co-founder and chief investment officer of Balasa Dinverno Foltz in Chicago. An early adopter, his $4 billion RIA now uses factor funds and ETFs for 90% of its equity portfolios.

For many advisors, examining the investment landscape through a factor lens produces a more granular picture of the choices and exposures they can create for clients. Some see it as an advanced, second-generation version of the traditional style-box perspective used by giant fund research concerns like Morningstar. Most academics in finance believe there are five genuine factors—value, quality, momentum, small cap or size and minimum volatility—that create more targeted options than capitalization size and growth versus value. 

When he explains factor investing to clients, Balasa draws a continuum starting with pure index investing, then moving on to factor investing followed by quant methodology and finally active investing at the end. Factor investing proponents adhere to various rules-based methodologies to deliver exposures to various sectors of the equity market and harvest premia over traditional market cap-weighted indexes.

While many established RIA firms have delivered decades of solid outcomes to clients using factor funds, the reality is that the last few years have been challenging—at exactly the same time these strategies have proliferated. Twice in recent months, Peter Lazaroff, co-chief investment officer of Plancorp, has found himself at an event where AQR Capital Management founder and CEO Cliff Asness, a thought leader in the field, was delivering the same address. His message: Essentially, nothing is working.

It wasn’t supposed to be that way. Many expected that increased computing power and data availability should be spawning more opportunities for index designers and both rules-based and active managers alike. As Lazaroff sees it, while traditional indexers view security selection as a zero-sum game, factor investing presumes that markets and prices contain vast quantities of information that can be harnessed to construct portfolios that deliver superior returns.

Academic research still indicates he is right. However, the consensus ends when it comes to product design and implementation.

Quality And Low Volatility

In recent years, two factors, quality and low volatility, have attracted billions in assets from advisors and investors seeking to participate in what they see as an extended, late-cycle bull market while getting a degree of downside protection. These two factors are complementary and share many similarities but also have key differences.

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