Your Money: Building a winning factor portfolio

financialexpress.com:

By Vineet Sachdeva

Factor investing is a technique of defining a set of factors and rules for selection and allocation of stocks in a portfolio, and then creating a rigorous, process-based system to implement these rules. The system eliminates manager biases in portfolio construction. Basically, factors are characteristics of stocks that explain their performance. Some examples of factors are high quality, undervalued, growth oriented, mid/small caps, etc.

Let us understand how to build a ‘system driven’ factor portfolio:

Value factor: The value factor strategy involves investing in assets that are considered undervalued relative to their intrinsic worth. This is done by comparing metrics such as price-to-earnings (P/E) ratios, price-to-book (P/B) ratios, or price-to-sales (P/S) ratios. Stocks with lower valuation multiples are seen as value stocks. Cheaper stocks are expected to outperform their expensive peers over the long term.

Size factor: The size factor strategy involves investing in smaller companies, typically measured by market capitalisation. Small-cap stocks are expected to outperform their larger peers over the long term. This strategy aims to capture the size premium associated with smaller stocks.

Quality factor: The quality factor strategy targets companies with strong fundamentals, such as high return on equity (ROE), low debt levels, and stable earnings growth. High-quality stocks are characterised by their ability to weather economic downturns and maintain profitability.

Momentum factor: Momentum factor investing focuses on investing in assets that have exhibited strong recent price performance. Stocks or other assets that have shown positive momentum in the past tend to continue to do so in the