This once-popular investing strategy is making a comeback…

Wednesday: The Independent Investor FROM THE DESK OF MILES EVERSON: Hi! We’re thrilled to share another investing insight in today’s “The Independent Investor!” Every Wednesday, we bring you investing insights because we believe diving into the world of investing can help you attain wealth creation and achieve financial freedom. Today, we will talk about a once-popular investing strategy that’s making a comeback. Read on if you want to know more about “factor investing” and how it can help you spot buying opportunities in the stock market. CEO, MBO Partners Chairman of the Advisory Board, The I Institute

This once-popular investing strategy is making a comeback… In 2015, Cliff Asness was about to become the next investing household name. At the time, his hedge fund, AQR Capital Management, had drawn significant interest from investors because of “factor investing,” its primary investment strategy. For those of you who don’t know, “factor investing” falls somewhere between classic stock picking and a fully quantitative approach. It involves determining factors driving market returns at any given time and buying stocks that fit those parameters. In 2015, the S&P 500 lost 1% while AQR gained roughly 15%. By 2017, the hedge fund had grown into the largest one in the world, with USD 226 billion in assets under management (AUM). AQR seemed unstoppable at the time…until “factor investing” stopped working. The fund seriously underperformed the S&P 500 over the next four years. When the market fell 6% in 2018, AQR fell more than 10%. When the S&P 500 rebounded 30% the next year, AQR barely eked out a 5% return. The result? Investors headed for the exits and redirected their money to fully quantitative hedge funds like Citadel and Point72 Asset Management. These days, AQR is down to USD 99 billion AUM, barely half the money it managed during its peak. While many investors are convinced “factor investing” is dead and have poured all of their capital to fully quantitative funds, AQR has been quietly staging a comeback. Before we explain why, we need to take a deep dive at the factors that drive funds like AQR. The Factors in “Factor Investing” Decades of research went into developing today’s most popular factors. Among these is the “value” factor, developed in 1977 by McMaster University professor Sanjoy Basu. Basu tested decades of stock returns and determined that cheap companies—those with low price-to-earnings (P/E) rations—outperformed expensive firms in the long run. From there, academics and practitioners developed other factors. For example, Eugene Fama and Kenneth French of the University of Chicago discovered that small stocks tend to outperform large stocks. Since then, several major factors have emerged, like high-profitability companies outperforming low-profitability firms, stocks with positive momentum outperforming falling stocks, and stocks with low volatility outperforming volatile ones. There’s a caveat though: The factors enumerated above outperform over the long term. On the other hand, investors pay more attention to short-term moves. Circling back to AQR, it became popular right when its strategy stopped working for a few years. At present, the fund seems to be back on track, as its flagship fund returned 17% in 2021. AQR also beat out the S&P 500 in 2022, with a 44% gain versus the market’s 18% loss. Furthermore, the hedge fund returned 19% last year, not far off from the S&P 500’s 24%. Due to these developments, AQR has been able to close the gap during the strong years for the S&P while outperforming the market during down years. — The factors that drive hedge funds like AQR are working again, and that means plenty of buying opportunities for investors are on the horizon. AQR focuses on small stocks with low volatility, low valuations, positive momentum and high profitability. The market rallied so much in 2023, making it hard to find cheap, high-quality companies. When another dip happens, true factor stocks will start showing up again. We still expect the U.S. to enter a recession soon, and when that happens, the stock market will likely dip, creating a perfect opportunity for investors to buy factor stocks with high long-term upside.     Hope you’ve found this week’s insights interesting and helpful. Did you know that the concept of debt is far older than the concept of money? Learn more about the importance of having good listening skills as an investor in next week’s article!