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Factor investing in equity and corporate bond markets: Neutralising bias

Outlooks & Research

Raul LEOTE DE CARVALHO
 

Factor investing is about using style factors such as value, quality, momentum or low risk to tilt portfolios in favour of cheaper (value) outperforming (momentum) stocks or corporate bonds from the most profitable and better managed (quality), less risky companies (low risk).

Such an approach is based on strong academic and empirical evidence that these stocks and corporate bonds should deliver the highest risk-adjusted returns.

But the way in which a portfolio is constructed can make a huge difference in terms of performance, to the extent that all expected outperformance may be wiped out by poorly constructed, factor-tilted portfolios.

Why? Because style factors are not the only factors that explain stock and corporate bond returns. Making sure that other factors do not pollute your portfolio by neutralising all biases can make all the difference.

In our paper ‘Factor investing in equity and corporate bond markets: neutralising bias’, we summarise some of the key factors that explain stock and corporate bond returns and provide a brief explanation of why this is the case. We also illustrate how costly poorly-constructed equity and corporate bond factor-based portfolios can be.

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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