Factor investing is familiar to institutional investors. Could it potentially strengthen your portfolio, too?
A core diversified portfolio should involve a blend of growth, value and quality stocks—and actively rotate among them to navigate different phases of market cycles. Growth, value and quality are also three factors with standout historical track records.
Here is an overview of what factors are, how those three important equity factors work and when each one could prove most useful for your core portfolio—and for achieving your investment goals.
Q: What are factors, and what are factor investing strategies?
A: Factors are broad, persistent drivers of risk and returns that investment professionals use to explain why a particular stock may be behaving in a certain way. Some examples of equity style factors are growth, momentum, low volatility, quality, value and size (market cap).
Isolating equity style factors helps us analyze trends, or reasonably consistent behaviors, to discover potentially favorable investing dynamics. Factors can be just as volatile and cyclical as equities (if not more so).
Factor investing involves selecting securities that have these risk and return drivers—favoring specific characteristics at certain times when they have been historically associated with higher returns.
Q: How has factor investing performed over time?
A: Over the last 25 years, three types of factor investing—growth, value and quality—have stood out due to these styles’ distinct attributes and impact on portfolio performance at different phases of the economic cycle.
Each factor and its inherent investment characteristics has a unique focus:
Q: Should a core portfolio emphasize one factor or invest in multiple factors?
A: A core diversified portfolio should involve a blend of growth, value and quality and actively rotate across factors to navigate different phases of market cycles. Historically, factors have had low correlation with one another, so by blending these three factor strategies, investors may potentially build a more resilient portfolio, according to their risk tolerance and market outlook.
Q: Is the goal of factor investing strengthening returns?
A: Yes, but the decision to invest in a factor strategy isn’t just about seeking the best return. It’s also about adjusting the portfolio’s volatility profile—and consequently, its risk-adjusted returns—because the clients’ experience of the investment journey toward their goals is paramount.
A key tenet of a core portfolio is that it helps you stay invested. If heightened market volatility and drawdowns scare you into selling at the wrong time, historically that has destroyed long-term value creation. For many investors, a smoother journey is vital.
Q: What is growth factor investing? What are the growth factor’s key characteristics?
A: Growth investing focuses on buying shares of companies that may be industry disruptors or have especially innovative products, making them likely to achieve earnings growth above the broader market average. The growth investor isn’t as concerned when a stock seems overvalued using a metric such as the price-to-earnings (P/E) ratio. These rapidly expanding companies often reinvest their profits to fuel further growth (and therefore capital appreciation), rather than paying out dividends.
Growth investors typically look to sectors such as technology and healthcare (and biotech) where innovation drives rapid development and a company’s market expansion.
If you want a regular income stream from your core portfolio, this may not be the best strategy. Growth investors may take profits in place of distributions. If they do so, however, they must be aware of the tax implications, and the possibility that generating liquidity by selling their growth holdings at the wrong time (i.e. during periods of market weakness) could have negative long-term impacts.
Q: When is an example of a time that growth stocks (and the growth factor) did particularly well?
A: Growth stocks outperformed other factors, and the broad market, in 2020, the year of the Covid -induced market drawdown. The MSCI World Growth Index rose 34% in 2020, far outperforming the broad MSCI World Index, which ended 2020 up 16% (Exhibit 1).
Growth stocks’ performance has been driven recently by the technology, artificial intelligence and internet sectors, most dramatically in 2023 and 2024 when the “Magnificent 7”1 dominated the stock market. A similar period occurred as pandemic lockdowns shifted consumer behaviors towards using digital services.
The low interest rate environment during Covid-19 meant these companies also enjoyed reduced borrowing rates, helping their future earnings become more valuable and contributing further to the growth stocks’ attractiveness.
Q: What is value investing? What are the value factor’s characteristics?
A: Value investing identifies companies that are trading less expensively than their fundamentals (sales, earnings or assets) might imply. Value investing isolates stocks at discounted prices and holds them over the long term, anticipating that their market price will eventually rise to reflect their actual intrinsic value, yielding the investor substantial returns.
Value investing emphasizes the idea of buying companies that are trading at a wide discount to their intrinsic value. This helps create a “margin of safety,” as value investors refer to it, because it helps protect against downside risk (since the company is already trading at a discount) and potentially overpaying for the stock.
Another key value investing idea: Even at times of market volatility, you gain a sense of protection because you’ve focused on the long-term intrinsic value of the company, relative to its current price.
Q: When is an instance when value stocks and the value factor did particularly well?
A: When the dot-com bubble burst in March 2000 and the market saw a dramatic drawdown, value stocks provided robust protection for investors from the significant declines of the growth stocks that had dominated market performance during the dot-com bubble.
From the dot-com peak to the bubble burst’s trough (Exhibit 2), the MSCI Value Index declined about 39%, a better outcome than the MSCI Growth Index (which posted a 56% decline) and superior to the broader MSCI World Index (down 46% peak to trough). Value stocks emerged from the tumult of 2000 as the more stable investment choice.
Value demonstrated the same resilience from late 2020 to early 2021 when the market rebounded. Although growth stocks led the market initially, investors shifted their focus to stocks that were undervalued and appeared poised to bounce back once the economy rebounded. Value returned 35% in this period, compared to growth (20%) and the broader index (27%). (All returns are net total MSCI World Index and sub-indexes).
Q: What is quality investing?
A: Quality investors focus on stocks that will do well whether markets are up or down. Quality investing differs from value investing in that investors focus less on stock’s current price and whether it appears under- or overvalued. Instead, they invest in companies with strong fundamentals, such as high return on equity, robust earnings growth and solid balance sheets. The goal is for these investments to deliver consistent performance over the long term, minimizing risks and maximizing returns.
Q: When has quality demonstrated resilience?
A: During the global financial crisis from 2007 to 2009, quality equities demonstrated more resilience than the lower quality part of the market (using MSCI indexes for comparison). Quality declined 34%, compared to the broad market’s 49% fall and value’s 54% plunge. Quality stocks also recovered more quickly after the financial crisis and went on to outperform growth and the broader market during the subsequent bull market of 2008–12 (Exhibit 3).
Q: What market conditions can be expected to spotlight each factor’s strengths (and risks)?
A: Growth, value and quality investing strategies’ distinct approaches have their own sets of benefits and risks. These factors’ performance can vary depending on the economic backdrop (Exhibit 4). It’s essential to recognize that market conditions are cyclical and can sometimes shift rapidly.
Growth stocks may outperform during periods of economic expansion but lag during recessions or corrections. Conversely, value stocks can be expected to excel during the periods of economic recovery that follow downturns. Quality stocks are generally more neutral and cyclical: They have historically served as a safeguard during both bullish and bearish markets, offering stability and reliable returns across market cycles.
For illustrative purposes only.
Q: Can factor investing be customized within a core portfolio?
A: Yes. A diversified core portfolio should involve a blend of these factors and actively rotate among factors to navigate different market cycles. Since factors have shown low correlation with one another historically, as we have noted, by blending these strategies, investors may build a more resilient portfolio suited to their risk tolerance and market outlook.
There is no single right answer or perfect approach to factor investing. Our proprietary technology and insight allow us to navigate through any market environment, helping our clients reach their long-term investment goals in a personal and tailored way.
Your J.P. Morgan Private Bank team can help you to incorporate your own views on factor investing and how that might impact your portfolio’s risk and return.
Indices are not investment products and may not be considered for investment
MSCI World Index: The MSCI World Index is a stock market index that represents large and mid-cap equity performance across 23 developed countries. It is designed to provide a broad measure of global equity market performance, excluding emerging markets. The index includes companies from North America, Europe, and Asia-Pacific, and is widely used as a benchmark for global equity funds
MSCI Value Index: The MSCI Value Index is designed to measure the performance of the value segment of the market. It includes companies that exhibit value characteristics, such as low price-to-book ratios, low price-to-earnings ratios, and high dividend yields. The index is constructed by selecting stocks from the broader MSCI indices that are considered to be undervalued relative to their peers. The MSCI Value Index aims to capture the performance of stocks that are perceived to be trading below their intrinsic value.
MSCI World Growth Index: The MSCI World Growth Index is designed to measure the performance of the growth segment of the market. It includes companies that exhibit growth characteristics, such as high earnings growth rates, high price-to-earnings ratios, and strong revenue growth. The index is constructed by selecting stocks from the broader MSCI indices that are considered to have strong growth potential. The MSCI World Growth Index aims to capture the performance of stocks that are expected to grow at an above-average rate compared to the overall market.
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