Fundamental Factors That Improve Your Investments: A Practical Guide

Abstract

We explore how investors can use the factors that drive their portfolio returns, focusing on fundamental factors instead of the widely discussed style factors. Fundamental factors explain the majority of the return variation among assets. There are times that a given factor sensitivity offers exceptionally high or low rewards in all assets exposed to it. We present an intuitive framework for measuring and steering fundamental factors in a portfolio. Practical examples show how to identify factor concentration risks and tilt a portfolio toward desired exposures. We argue that investors best use a factor-based approach in conjunction with traditional asset allocation, rather than as a substitute. In addition, we provide suggestions on how to embed the factor-based approach within an existing investment process.

TOPICS: Factor-based models, portfolio construction, performance measurement