# 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. Source: https://learn.tradelabsai.com/research/factor-investing-explained/ Track: Research and Backtesting · Level: Advanced · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Factor Investing Explained", https://learn.tradelabsai.com/research/factor-investing-explained/ 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](https://learn.tradelabsai.com/portfolio/alpha-and-beta/) | | Value | Cheap stocks outperform expensive ones | [Value Factor](https://learn.tradelabsai.com/research/value-factor/) | | Size | Small companies outperform large ones (historically, inconsistently) | [Size Factor](https://learn.tradelabsai.com/research/size-factor/) | | Momentum | Recent winners keep outperforming recent losers | [Momentum Factor](https://learn.tradelabsai.com/research/momentum-factor/) | | Quality and profitability | Profitable, stable, conservatively financed firms outperform | [Quality and Profitability Factors](https://learn.tradelabsai.com/research/quality-factor/) | | Low volatility | Less volatile stocks deliver better risk adjusted returns | [Low Volatility and Defensive Factors](https://learn.tradelabsai.com/research/low-volatility-factor/) | | Carry | Higher yielding assets outperform lower yielding ones | [Carry Factor](https://learn.tradelabsai.com/research/carry-factor/) | | Liquidity | Less liquid assets earn a premium | [Liquidity Factor](https://learn.tradelabsai.com/research/liquidity-factor/) | | Investment | Firms that invest conservatively outperform aggressive investors | [Growth and Dividend Factors](https://learn.tradelabsai.com/research/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](https://learn.tradelabsai.com/portfolio/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](https://learn.tradelabsai.com/research/combining-signals/) | | Factor timing | Vary exposure based on valuations or conditions; difficult in practice | **Example: Building a simple factor portfolio** Each month, rank the 1,000 largest US stocks by book to market. Buy the top 30% (cheapest) and short the bottom 30% (most expensive), equal weighted. The return of this long short portfolio is a value factor return. The famous HML (high minus low) factor of Fama and French is built in a similar way with additional size sorting. Factor returns like this are published freely by Kenneth French's data library. ## 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](https://learn.tradelabsai.com/psychology/recency-bias/). ## Risks and criticisms - **Data mining:** hundreds of "factors" have been published; many fail to replicate. See [P-Hacking and Multiple Testing](https://learn.tradelabsai.com/research/p-hacking-and-multiple-testing/). - **Crowding:** popular factors attract capital, lowering future returns. See [Factor Timing, Crowding and Crashes](https://learn.tradelabsai.com/research/factor-crowding/). - **Costs:** high turnover factors such as momentum can lose much of their premium to trading costs. See [Signal Turnover, Breadth and Neutralization](https://learn.tradelabsai.com/research/signal-turnover/). - **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](https://learn.tradelabsai.com/research/value-factor/). ## Sources - Kenneth R. French, [Data Library](https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html) ## Continue learning - Next lesson: [Value Factor](https://learn.tradelabsai.com/research/value-factor/) - Previous lesson: [Signal Turnover, Breadth and Neutralization](https://learn.tradelabsai.com/research/signal-turnover/) - Related: [Signal Turnover, Breadth and Neutralization](https://learn.tradelabsai.com/research/signal-turnover/): Turnover measures how much a portfolio trades. Learn how to calculate it, how it links signal decay to costs, and techniques to cut turnover without losing alpha. - Related: [Value Factor](https://learn.tradelabsai.com/research/value-factor/): The 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. - Related: [Momentum Factor](https://learn.tradelabsai.com/research/momentum-factor/): The momentum factor buys recent winners and sells recent losers. Learn how it is built, the evidence across markets, momentum crashes and how to manage them. - Related: [Quality and Profitability Factors](https://learn.tradelabsai.com/research/quality-factor/): The quality factor favours profitable, stable, conservatively financed companies. Learn how quality is measured, the evidence and how it pairs with value. - Related: [Factor Models](https://learn.tradelabsai.com/portfolio/factor-models/): Factor models explain asset returns with common drivers such as the market, size, value and momentum. Learn CAPM, Fama French and how to run a factor regression. - Related: [Factor Timing, Crowding and Crashes](https://learn.tradelabsai.com/research/factor-crowding/): Factor crowding happens when too much capital chases the same factor. Learn how crowding affects returns and crash risk, how to measure it and how to cope.