Factor investing involves style factors such as value, quality, momentum or low risk (volatility). These factors are used to select securities such as equities and corporate bonds and tilt investment portfolios in favour of cheaper (value), outperforming (momentum) stocks or corporate bonds issued by the most profitable and better managed (quality), less risky companies (low risk).
Putting together a factor-based portfolio can be challenging. There is more to stock and bond returns than just style factors. Making sure other factors do not interfere can make all the difference.
Factors can be grouped into two sets:
- Factors that explain differences in the returns
- For stocks: market factor, sector, region and size
- For corporate bonds: duration, risk premium, sector, currency and size.
- These style factors tend to predict future differences in returns
- value, quality, low risk and momentum.
Investing using the second set of style factors can be combined with an approach that integrates environmental, social and governance (ESG) criteria. Incorporating sustainability and climate change criteria can help identify and limit reputational, operational and financial risks.
This is true not just in the case of factor investing; an ESG approach can be applied to all investment processes. This is why BNP Paribas Asset Management implements such an approach across its entire offering.