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Professional · Lesson 2 of 4The main equity factors
Value: cheap shares (low price-to-book or price-to-earnings) have historically outperformed expensive ones over long periods, though value lagged badly from about 2007 to 2020. Size: small companies have historically earned more, but the effect is weak after costs. Momentum: recent winners tend to keep winning for 3-12 months, with occasional sharp crashes.
Quality/profitability: profitable, stable, low-debt firms have outperformed (Novy-Marx 2013; Fama-French five-factor model 2015). Low volatility: lower-risk shares have delivered similar or better returns than high-risk shares, contrary to CAPM.
Factor ETFs ("smart beta") package these. Combining factors that do well at different times, such as value and momentum, can smooth results.
Key takeaways
- Value, size, momentum, quality and low volatility are the main factors.
- Every factor has long periods of underperformance.
- Combining factors smooths returns.
Check your understanding
1. Which factor suffered a long drought from about 2007 to 2020?
- Momentum
- Value
- Quality
- Low volatility
Show the answer
Value. Growth shares dominated that period.
2. The low-volatility anomaly contradicts CAPM because...
- Low-risk shares earned similar or higher returns
- High-risk shares earned more
- Volatility was zero
- It only works in bonds
Show the answer
Low-risk shares earned similar or higher returns. CAPM predicts higher risk earns more.
Go deeper
- Wikipedia: Factor investing
- YouTube videos: factor investing value momentum quality explained
- Investopedia: factor investing
- Wikipedia: Fama–French three-factor model
- Wikipedia: Low-volatility anomaly
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