“Factor investing” gains popularity

RETAIL investors tend to dream of finding a wonder stock—a Netflix or Apple that will multiply their savings many times over. But institutional investors cannot commit too much capital to one individual company. Instead, they hope to pick the right kind of stocks, a broadly based group that will beat the market.

Two or three decades ago, fund managers would have attempted this feat by favouring one industry over another. They might, say, have bought energy stocks in the hope that the oil price would rise, while avoiding retailers because of fears about consumer spending. But in these days of computers and algorithms, there are more systematic approaches to beating the market. The aim is to find stocks with characteristics or “factors” that make them outperform. In the industry jargon, funds tracking these factors are known as “smart beta”. The money allocated to smart-beta exchange-traded funds has reached $658bn; all told, more than $1trn is invested in an explicitly factor-based fashion.