Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 253

How to use factors to tailor your investing

Factor-based investing has gained greater attention in recent years, in part because of the rise of alternatively-weighted indexes and ‘smart-beta’ products.

However, investing in factors is nothing new. Benjamin Graham and David Dodd published ideas on what we now call value investing in their book Security Analysis published in 1934.

Portfolios might tilt towards or away from certain factors. What is new about factor-based investing is using the factor lens to evaluate portfolios, crediting factors for their impact on risk and return.

Today, value investing is considered one type of factor strategy - with minimum volatility, quality, momentum and liquidity being other common factor strategies.

We think of factors as the DNA of an investment – the underlying attributes that explain and influence how an investment behaves. Factor strategies leverage the positive effects of factor exposures through systematic, diversified, and disciplined tilts.

With an increasing array of factor funds on offer, deciding what’s right for your portfolio can be difficult. By keeping some fundamentals in mind, investors can work out what might genuinely assist in reaching their financial goals.

Align your goals with your investment choices

How you use factors when constructing a portfolio depends on your goals. Rather than targeting pure outperformance with factor funds, you might be better off considering the kind of characteristics a certain factor can add to your portfolio. Your goals may involve specific time-horizon constraints, or varying risk profiles.

For example, those in pension phase with concerns about volatile markets may see the benefit in using a factor fund focused on minimising volatility in part of their equity exposure. This might apply especially when reallocating too large a sum to fixed interest could jeopardise the capital growth required to protect against outliving assets.

Historically, an investor may have looked towards equity funds that emphasised ‘defensive’ sectors or those with higher dividend yields for volatility reduction. However, while lower volatility can be, at times, a by-product of these types of strategies, it is not the objective. Additionally, products like these may lack proper diversification and not provide the downside protection when needed the most.

A minimum volatility strategy is optimised to provide equity returns with lower volatility than the broad markets in a diversified portfolio.

Alternatively, a growth-oriented investor might conclude that the style characteristics of their total global equities portfolio are not appropriate for the level of desired risk. If the investor wishes to maintain the outperformance potential of their existing funds while reducing the active risk, they could allocate a portion of their global equities portfolio to a value fund providing a value equity factor tilt.

Active or index?

Historically, investors may have accessed factor exposure through non-market capitalisation, index-weighted strategies. However, we view any portfolio that uses a non-cap-weighted scheme as an active portfolio. Factor-based investing uses factors like value, minimum volatility or a tilt to a certain sector to outperform the broader markets.

Using an active approach to factor implementation can provide greater control over factor exposure and reduce factor drift in the portfolio, with the flexibility to change portfolio holdings as needed. This is because positions can be adjusted as needed in order to maintain continual dynamic exposure to targeted factors.

Adopting lower cost active management to replace higher cost traditional active funds can remove one of the most persistent headwinds to active outperformance.

Consider the risks

Using factor products can help you employ a transparent, controlled active approach towards meeting your goals, but factor investing is not without risks. Similar to many forms of active management, factors can perform inconsistently and experience sustained periods of underperformance.

Factor-timing is difficult, in fact like any active tilt, factors carry higher risk relative to the broad market, and demand patience and conviction from investors. They must have the ability to resist the urge to sell down underperforming active positions which may recover and provide outperformance over the longer term.

Rather than trying to identify a sure-fire solution for outperformance in all market cycles, factor strategies should match your investment objectives and be sure you have the patience needed to stick with the strategy over the long term.

 

Michael Roach is Head of Quantitative Equity Group at Vanguard Australia, a sponsor of Cuffelinks. This article is in the nature of general information and does not consider the circumstances of any investor.


 

Leave a Comment:

RELATED ARTICLES

The best opportunities in fixed income right now

Finding your investment niche

Is currency exposure an unwanted risk or source of returns?

banner

Most viewed in recent weeks

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Latest Updates

Investment strategies

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

Shares

Why the ASX needs dual-class shares

The ASX is exploring the introduction of dual class share structures for listed companies. Opposition is building to the plan but the ASX should ignore the naysayers and bring Australia into line with its global peers.

The state of women's wealth in Australia

New research shows the average Australian woman has $428,000 in net wealth, 40% less than the average man. This takes a deep dive into what the gender wealth gap looks like across different life stages.

Investing

The two most dangerous words in investing

Market extremes are where the biggest investment risks and opportunities lie. While events like this are usually only obvious in hindsight, learning to watch out for these two words can alert you to them in real time.

Shares

Investing in the backbone of the digital age

Semiconductors are used to make microchips and are essential to a vast range of technology and devices. This looks at what’s driving demand for chips, how the industry is evolving, and favoured stocks to play the theme.

Gold

Why gold’s record highs in 2025 differ from prior peaks

Gold prices hit new recent highs, driven by a stronger euro, tariff concerns, and steady ETF buying – all while the precious metal’s fundamental backdrop remains solid amid a shifting global economic landscape.

Now might be the best time to switch out of bank hybrids

In this interview, Schroders' Helen Mason discusses investing in corporate and financial credit securities, market impacts of tariffs, opportunities for cash investments, and views on tier two and hybrid bonds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.