A style factor is an isolated characteristic of a stock. There are variety of style factors: Growth, Value, Momentum, etc. They can get pretty niche, but we will focus on the well observed ones.
An example is the Value factor. To put it simply, Value factor methodology typically ranks a stock universe by P/E, P/B, dividend yield, and other fundamental metrics. The stocks that are in the bottom 20% of the ranking will then be considered “Value” factor stocks, since they are trading with such “undervalued” multiples relative to the market average. If S&P 500 has a forward P/E of 15, and the bottom 20% of stocks have a multiple of 9, historically this has been considered “Value stocks” since they are so trading at such a discount to the weighted average of the market. A portfolio is then created that will hold these cheaper stocks.
There is a TON more that goes on under the hood, feel free to investigate various style factor methodologies if you wish to get into the weeds. But I’m hoping this is enough to make you feel moderately comfortable.
Now to the Momentum factor—the Momentum factor assumes that companies that have been trading higher will continue to do so in the near-term. “Near-term” is defined differently according to the ETF, it ranges from a few months to a year. Read the ETF methodology if you care to learn more.
A variety of research papers have found that the Momentum factor consistently delivers excess returns. According to MSCI, the Momentum factor generated an annualized excess return of 13% over MSCI World during a 40-yr period. Going back to 1986, Fidelity found an average annual 1.5% excess return over Russell 1000. Momentum's Sharpe ratio is on the more volatile than other common factors, so please keep this mind when opening a position.
There’s a plethora of academic research on the Momentum factor, so feel free to get more into the weeds yourself if you wish.
The largest Momentum ETF is MTUM, with $12 billion in AUM. There are tons of others. Do some due diligence and pick one if it suits your risk tolerance.
Happy Friday!
(IMPORTANT caveat! This Value factor methodology I described has been argued to be a poor representation of Value. This methodology may have been a good way to screen for stocks decades ago, but IMO, most stocks in the lowest 20th percentile should be trading there. Value factor investing != Value investing. Please keep this mind when making buy/sell decisions.)
(2nd IMPORTANT caveat! For the pedants—I’m painting with fat ass brush in the above write-up. There are a million different methodologies to construct a factor portfolio, I realize that. I skipped over a ton and the odds of me mischaracterizing some part of the process is high, so focus on the spirit of what I’m describing.)
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