Chefs often vary a restaurant’s menu from season to season to emphasize ingredients that peak at different times of the year. There are many reasons for this but the most important—for those eating the food, at any rate—comes down to quality. In August, a chef may serve a salad that features tomatoes bursting with summer flavor and then, in January, swap the tomatoes for a bright citrus fruit like grapefruit.  It’s not that tomatoes are better than grapefruit or vice versa, it’s that, on a relative basis, one ingredient will outperform others under specific conditions, in this case, the season.  

Factor investing bears some similarities to seasonal cooking. Certain factors perform better in certain environments. It’s up to investors to act as the chef, adjusting factor exposures within a portfolio to play to each one’s strength, given current market conditions. When it comes to understanding factors, however, investors often spend considerable time reviewing an individual factor’s historical data, such as risk and returns, to understand how it performed over market cycles. While relevant, from a portfolio construction perspective, we think it can also be beneficial to compare and contrast factor exposures relative to one another across a set of fundamental characteristics. Depending on what may or may not be in favor—or “in season”—this analysis can provide insight into future performance potential.

Digging Deeper into Specific Factors

Single-factor strategies focus on an individual factor that academic research has identified as a powerful driver of excess returns. While still debated by academic experts, it is now generally agreed that there are six key factors that can drive long-term returns—Value, Quality, Size, Low Volatility, Momentum and Yield. Let’s break down what each of these factors is and how its index is defined. Exhibit 1 then highlights how these factors look relative to one another today based on a set of fundamental characteristics.


The concept underlying the value factor is that stocks that appear cheap tend to perform better than those that appear expensive. It is defined by ranking companies based on a composite of cash-flow yield, earnings yield and price-to-sales ratios.

As one may expect, value stocks are less expensive than the broader market. One reason for this is that value companies may be riskier because they have more leverage than the broader market, visible in their higher debt-to-equity ratios. They also tend to have relatively low profit margins, implying that they are not as flexible and profitable as the broader market, and have lower expected earnings growth.


Higher-quality companies tend to perform better over time than lower-quality companies. The quality factor is measured by ranking companies based on a composite of profitability, efficiency, earnings quality, and leverage.

Return on equity (ROE) is the fundamental characteristic most closely associated with quality. It's clear that quality stocks have a much higher ROE than the market. They also offer lower leverage and lower dividend payout ratios. In today's market, quality stocks also have higher estimated long-term earnings-per-share (EPS) growth. However, quality stocks trade at premium valuation multiples.


Conceptually, the size factor is grounded in the notion that smaller companies tend to outperform larger companies. Size is measured by ranking companies based on their full market capitalization.

The size and value factors share some similarities from a fundamental characteristic perspective because smaller companies are inexpensive relative to the broader market. They also have lower profit margins. However, the predicted beta for the size factor is higher than it is for value and the broader market. Interestingly, leverage and expected earnings growth for smaller companies is relatively in line with the market.

Low Volatility

The low volatility factor is based on the idea that stocks that exhibit lower volatility tend to perform better than stocks with higher volatility. This is in contrast with many investors’ expectations that higher risk should generate higher return. It’s measured by ranking companies based on their standard deviation of five years of total returns.

Low volatility price multiples tend to be higher than the market, while the companies exhibit weaker expected earnings growth. As one may expect, predicted beta for low volatility companies is below that of the market. They also have higher dividend yields coupled with dividend payout ratios that are consistent with broader market. Profit margins and ROE are well ahead of the market, suggesting that low volatility companies are more profitable than the market average.


The momentum factor suggests that stocks that rise or fall in price tend to continue rising or falling in price. Momentum stocks are defined by ranking companies based on their cumulative 11-month return.

Momentum picks up on recent trends in the market, so exposures may be highly variable through time. In today's market, momentum offers investors exposure to stocks with higher expected earnings growth, profit margins, ROE, and beta. On the other hand, momentum today offers a lower dividend yield and the securities are relatively expensive. They also have low dividend payout ratios.


The concept behind the yield factor is that higher-yielding stocks tend to perform better than stocks with lower yields. Yield is measured by ranking companies based on their 12-month trailing dividend yield.

Like value and size, low volatility and yield share many similarities from an exposure point of view. Each has low beta and earnings growth below that of the market. However, yield offers a much higher dividend yield and dividend payout ratio compared with the market. Interestingly, profit margins are high relative to the market, while valuation multiples are comparatively low

CharacteristicsMomentumQualitySizeValueVolatilityYieldMarket Cap
Dividend Yield (%)1.641.791.812.
Price-to-Book (x)3.004.532.362.193.052.672.97
Price-to-Sales (x)2.322.351.481.182.171.932.06
Price-to-Free Cash Flow (x)18.9920.4716.2513.6518.7916.8118.76
Price-to-Earnings (x)21.3622.6220.6316.1320.4318.5421.08
Estimated Long-Term EPS Growth (%)12.6012.0811.669.0110.058.9411.67
Total Debt to Common Equity (%)132.7180.45121.73143.64114.60128.57119.83
Dividend Payout Ratio (%)56.2141.5770.1460.3272.17128.0571.69
Return on Common Equity (%)13.3619.596.8412.9814.6912.9212.72
Profit Margin (x)10.149.904.256.9210.279.398.69
Predicted Beta (%)

Source: Bloomberg Finance, L.P., as of 8/31/17.

Analyze Factors to Invest Like a Chef

In much the same way that summer favors tomatoes, certain market environments favor specific factors. Value, for example, tends to perform best in periods of economic recovery. We saw this in 2016, particularly following the U.S. presidential election, when value outperformed on the expectation that President Trump, alongside a Republican Congress, would reignite economic growth. When that trade stalled, quality came into favor as investors were willing to accept higher valuations for higher growth potential.

Whether an investor is looking to integrate some factor exposure alongside passive or active strategies, or plans to construct a factor-based portfolio from the ground up, evaluating factors side by side, with a focus on fundamental characteristics, can lead to more informed decision-making. Combining this knowledge with an understanding of what performance catalysts the market may be seeking can help investors keep their portfolios “in season.”