Factor Investing

A multifactor investment strategy systematically tilts a portfolio toward multiple dimensions of expected return. Peer-reviewed academic research has identified several factors—like value, size, profitability, and investment—that have historically commanded risk premiums. Rather than timing markets or picking individual stocks, multifactor strategies overweight securities with favorable factor characteristics and underweight those without them. The key insight is diversification across risk sources. Different factors perform differently across economic states. By combining exposures to multiple factors, investors can potentially earn higher expected returns while avoiding the concentration risk of betting on a single anomaly. It's a disciplined, rules-based approach grounded in decades of empirical evidence.

Market prices, combined with fundamental company data like balance sheets and income statements, contain valuable information about expected returns.

In a multifactor framework, we examine cross-sectional differences in company characteristics. Securities with similar risk profiles should offer similar expected returns—so when we observe persistent return differences associated with factors like value, profitability, or investment, we are most likely identifying risk premiums.

We use quantitative methods to systematically tilt toward characteristics historically associated with higher average returns. Relative valuations and firm fundamentals guide which securities to overweight in portfolio construction.

The profitability factor, or RMW—Robust Minus Weak—looks at the difference in returns between highly profitable companies and those with weaker profits. It’s set up as a long-short portfolio, going long the strong and short the weak.

At Integrity, we tilt toward companies with solid profitability, aiming to capture higher long-term expected returns for our clients.

The value factor, or HML—High Minus Low—shows the historical return premium of value stocks over growth stocks.

The factor is built as a long-short portfolio: long high book-to-market companies, short low book-to-market companies.

At Integrity, we tilt portfolios toward value characteristics to capture higher long-term expected returns.

The size factor, or SMB—Small Minus Big—captures the historical tendency of small-cap stocks to outperform large-cap stocks. It’s built as a long-short portfolio, going long small companies and short large ones. At Integrity, we tilt portfolios toward smaller firms to harness this size premium to improve overall portfolio long-term expected returns.

At Integrity, we define a factor as the return stream created by a long-short portfolio formed on a sorting characteristics like size, value, or profitability.

These long-short factor returns help us understand how certain traits have historically contributed to performance. We use this framework to tilt our portfolios toward characteristics that have been linked with higher long-term expected returns.