Factor-based investing: A smarter way to handle market ups & downs

Francois Rochon famously said, “The key to investing isn’t avoiding market fluctuations—it’s learning how to turn them into opportunities.” One couldn’t agree more.

Markets, much like life, are unpredictable. The last few months and years have been a rollercoaster ride for Indian investors—volatile equity markets, fluctuating interest rates, and geopolitical tensions have kept everyone on edge. Traditional investment strategies often struggle to cope with these swings. This is where factor-based investing steps in, offering a scientific, time-tested approach to building resilient portfolios.

As investors, we often ask ourselves: Should I chase momentum or seek undervalued stocks? Should I focus on quality or diversify across sectors? Factor-based investing answers these questions which may help in identifying characteristics that drive long-term returns. And in uncertain markets, these factors act as guiding lights, helping investors stay on track without getting swayed by short-term noise.

Understanding the concept

Factor-based investing is an advanced investment strategy that focuses on specific characteristics that drive long-term returns. Instead of relying solely on market-cap-weighted approaches, this strategy identifies patterns that have historically influenced stock performance. Factors can be broadly categorised into style factors like quality, value, momentum, low volatility and size, as well as macro factors such as interest rates, inflation, and economic growth.

Each factor plays a unique role in identifying investment opportunities. The quality factor focuses on financially strong companies with consistent earnings, low debt, and stable growth, making them more resilient during economic downturns. The value factor identifies fundamentally strong stocks trading at a discount, providing long-term appreciation. Momentum investing involves capitalising on stocks with strong recent performance, while the low volatility factor offers a smoother investment experience by minimizing market fluctuations. The size factor highlights the growth potential of smaller companies, though with higher risks.

The evolution

Factor-based investing has evolved significantly, giving rise to smart beta, multi-factor investing, and dynamic factor models. Smart beta blends traditional index investing with factor-based strategies to enhance returns and manage risk. Multi-factor investing combines multiple factors in a single portfolio, reducing dependency on a single market condition. Dynamic factor investing adjusts factor exposure based on changing market conditions, ensuring resilience over time.

Managing risk

While factor investing provides a structured way to enhance returns, it is not without risks. Relying on a single factor can expose portfolios to cyclicality, making diversification across multiple factors crucial. Understanding market cycles is equally important, as different factors perform well at different times - Value may shine post market corrections, while Momentum thrives in bullish trends. Active monitoring and rebalancing are essential to maintain optimal factor exposure and align with evolving market conditions.

Portfolio construction

For investors looking to adopt factor investing, defining clear investment goals is the first step. Choosing the right factors based on risk tolerance and investment horizon is key. A well-balanced approach that diversifies across factors can enhance risk-adjusted returns. Considering dynamic or multi-factor strategies provides flexibility to adapt to market conditions, while regular monitoring ensures optimal portfolio performance.

The road ahead

Factor investing is no longer limited to institutional players. These strategies are now available through actively managed quantamental funds, which blend factor models with fundamental analysis for an enhanced investment approach. Market cycles will come and go, but a structured approach can help investors stay the course. Factor-based investing isn’t about chasing trends—it’s about applying data-driven, logical methods to investing, reducing emotional biases, and ultimately building wealth more effectively.

Happy investing!