Research Affiliates

By buying or overweighting characteristics-based factor exposure and selling or underweighting beta-based factor exposure, investors can position their portfolios to reap the rewards of factor investing while bearing less risk.

Value investing has underperformed growth investing for the last 13.5 years. The drawdown is the longest and deepest since 1963 and is explained by value becoming unusually cheap relative to growth. As of June 30, 2020, the relative valuation of the HML value factor fell to the 100th percentile of the historical distribution.

Factor investing has failed to live up to its many promises. Its success is compromised by three problems that are often underappreciated by investors. 

Unlike standard factors, such as value, momentum, and size, “quality” lacks a commonly accepted definition. Practitioners, however, are increasingly gravitating to this style factor. 

Valuation, always an effective tool for long-term investors, can also be useful for assessing short-term market prospects. The authors demonstrate that conditioning CAPE on current inflation and real yields substantially improves its accuracy in forecasting returns for periods from one month to one year. 

Not every factor profits investors when implemented through a passive strategy. Size and quality show weak robustness, and liquidity-demanding factors, such as illiquidity and momentum, are associated with high trading costs.

Although hidden, the implicit market impact costs of factor investing may substantially erode a strategy’s expected excess returns. The rebalancing data of a suite of large and long-standing factor-investing indexes are used in this study to model these market impact costs.