Since the work of Eugene Fama and Kenneth French, academic research has identified “factors”: shared characteristics that historically explain a significant part of returns, well beyond simple market risk.
The best-documented factors
- Value: cheap stocks (relative to their fundamentals) have historically outperformed expensive ones.
- Size: small caps have historically offered a premium, at the cost of higher risk and lower liquidity.
- Momentum: stocks that have performed well recently tend to keep doing so over the short to medium term.
- Quality: highly profitable, lightly indebted companies with stable earnings outperform at lower risk.
- Low volatility: a troubling anomaly — low-volatility stocks often show a higher risk-adjusted return, contradicting the theory.
Risk premium or anomaly?
Two explanations compete, and the debate is not settled. For the rational school, a factor compensates additional risk (value stocks would be more fragile in a recession). For the behavioural school, it exploits a persistent human bias (we overpay for exciting stories and neglect boring companies).
Patience is the price of entry
A factor can underperform for years: value went through a difficult decade after 2010. Those who give up at the worst moment never capture the premium: they endure the pain without collecting the reward. A factor is NOT a sure thing.
The arbitrage risk
A factor that becomes too well known can be arbitraged away: if everyone buys value stocks, their discount disappears. Some researchers observe premia eroding after their academic publication. Caution is called for in the face of overly clear-cut promises.
À retenir
- ✓Value, size, momentum, quality, low-vol: solidly documented factors.
- ✓Risk premium or behavioural bias: the debate remains open.
- ✓A factor demands years of patience, and can erode once widely known.