When it comes to deciding where to allocate capital, many investors favor a systematic approach, which helps to inform and empower decision-making. One example of such an approach is factor investing, in which investors study statistical similarities between their investments to find common factors they can leverage. This method is widely considered to be a solid investment strategy.
Read on to find out about factor investing.
Quantifiable and targeted characteristics, such as share liquidity and gross domestic product growth that can explain stock return disparities are referred to as investment factors. The thought goes back to 1976, with Stephen A. Ross’ arbitrage pricing theory. This philosophy maintained that multiple factors explained security returns.
Since then, academics and investors have identified several investment factors.
Factor investing seeks in part to mitigate risk. These include market, liquidity, credit, reinvestment, inflation, concentration, and time horizon risks. The factor investment approach is considered a way to offset prospective risks by targeting consistent, broad, and long-established drivers of returns.
Systematic investing focuses on scientific testing, data-driven insights, and disciplined portfolio establishment to evaluate the potential of an investment opportunity. Successful investors often use this strategy to gain varied portfolio outcomes.
A systematic approach strategy, founded on the study, selection, weighting, and rebalancing of investment portfolios is referred to as factor investing. The emphasis is on stocks that have been shown, overtime, to improve risk-adjusted returns.
Investors can uncover factors by using rules-based exchange-traded funds to track custom indexes. They may also do so using quantitative, actively managed funds.
Economy-related factors include:
Asset-Related factors include:
As with any type of investment strategy, there are pros and cons for factor investing:
In addition to the potential generation of above-market returns and risk management, factor investing was designed to enhance portfolio diversification. While no investment approach is risk-free, ownership of multiple assets that perform differently can mitigate overall portfolio risk.
Smart investors favor an investment mix that is not wholly dependent on the stock market. The online alternative investment platform Yieldstreet, for example, focuses on creating predictable secondary income streams across asset classes including art and commercial real estate.
The idea is to reimagine wealth creation to help investors produce income outside of traditional public markets.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened several carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Factor investing is a systematic investing approach that can be mixed with other investment approaches and techniques, including adding alternative assets to investment portfolios that have low correlations to volatile markets.
All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including the possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.