Factor Investing Explained: Value, Momentum and Quality

Factor Investing Explained

Factor investing targets traits linked to long run returns, such as value, momentum and quality. Learn the main factors, the evidence and how they are traded.

Advanced3 min readUpdated 3 Oct 2026

Lesson 28 of 38

Factor investing is an approach that tilts portfolios toward characteristics, called factors, that research has linked to differences in long run returns. Instead of picking individual stocks for their own stories, factor investors buy many stocks that share traits such as being cheap, having strong recent performance or being highly profitable. Factors are used by quantitative hedge funds, large asset managers and smart beta ETFs, and they are the language professionals use to explain where returns come from.

The main factors#

Factor	Idea	Lesson
Market	Stocks earn more than cash over time	Alpha and Beta
Value	Cheap stocks outperform expensive ones	Value Factor
Size	Small companies outperform large ones (historically, inconsistently)	Size Factor
Momentum	Recent winners keep outperforming recent losers	Momentum Factor
Quality and profitability	Profitable, stable, conservatively financed firms outperform	Quality and Profitability Factors
Low volatility	Less volatile stocks deliver better risk adjusted returns	Low Volatility and Defensive Factors
Carry	Higher yielding assets outperform lower yielding ones	Carry Factor
Liquidity	Less liquid assets earn a premium	Liquidity Factor
Investment	Firms that invest conservatively outperform aggressive investors	Growth and Dividend Factors

A brief history#

Year	Development
1960s	CAPM: the market is the only priced factor
1981	Rolf Banz documents the size effect
1992 to 1993	Fama and French three factor model: market, size, value
1993	Jegadeesh and Titman document momentum
1997	Carhart adds momentum (four factor model)
2013 to 2015	Profitability and investment factors; Fama French five factor model

See Factor Models.

Why might factors earn premiums?#

Explanation	Idea
Risk based	Factors are compensation for bearing risks investors dislike, such as distress or crash risk
Behavioural	Investor biases (overreaction, underreaction, lottery seeking) create mispricing
Structural	Constraints such as leverage limits or benchmarks push investors toward certain assets

The explanation matters: risk based premiums are more likely to persist; purely behavioural ones may be arbitraged away.

How factors are traded#

Approach	Description
Long only tilts	Overweight high factor stocks within a long only portfolio (smart beta ETFs)
Long short factor portfolios	Buy high scoring and short low scoring stocks; pure factor exposure
Multi factor portfolios	Combine several factors for diversification. See Combining Signals
Factor timing	Vary exposure based on valuations or conditions; difficult in practice

Factor performance is cyclical#

Factors can underperform for long periods. Value lagged growth for much of 2007 to 2020, one of its worst stretches on record, before rebounding strongly in 2021 and 2022. Momentum suffered a sharp crash in 2009. Investors who abandon factors during drawdowns often miss the recovery. See Recency Bias.

Risks and criticisms#

Data mining: hundreds of "factors" have been published; many fail to replicate. See P-Hacking and Multiple Testing.
Crowding: popular factors attract capital, lowering future returns. See Factor Timing, Crowding and Crashes.
Costs: high turnover factors such as momentum can lose much of their premium to trading costs. See Signal Turnover, Breadth and Neutralization.
Long drawdowns test investor discipline.

Frequently asked questions#

What is factor investing?#

An approach that builds portfolios around characteristics, such as value, momentum or quality, that research has linked to long run return differences.

What are the main investment factors?#

Market, value, size, momentum, quality or profitability, low volatility, carry and investment.

Do factors always work?#

No. Factors can underperform for many years, may be weakened by crowding and costs, and some published factors were never real.

Next, study the oldest factor in Value Factor.

Sources#

Kenneth R. French, Data Library

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Next lessonValue FactorThe value factor buys cheap stocks and avoids expensive ones using ratios like book to market. Learn the evidence, the long drawdown and how to build it.