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Factor investing is an investment approach that involves targeting quantifiable firm characteristics or "factors" that can explain differences in stock returns. Security characteristics that may be included in a factor-based approach include size, low-volatility , value , momentum , asset growth, profitability, leverage, term and carry .
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In portfolio management, the Carhart four-factor model is an extra factor addition in the Fama–French three-factor model, proposed by Mark Carhart.The Fama-French model, developed in the 1990, argued most stock market returns are explained by three factors: risk, price (value stocks tending to outperform) and company size (smaller company stocks tending to outperform).
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The factor returns are then fit to a second stage model of the form (,,) = (,,) (,) + (,,) Here Y gives the exposure of local factor (i,j) to the global factor whose return is g(k,t) and h(i,j,t) is the local specific factor return. The covariance matrix of factor returns is estimated as
In 2015, Fama and French extended the model, adding a further two factors — profitability and investment. Defined analogously to the HML factor, the profitability factor (RMW) is the difference between the returns of firms with robust (high) and weak (low) operating profitability; and the investment factor (CMA) is the difference between the returns of firms that invest conservatively and ...
It was proposed by investor and professor of Columbia University, Benjamin Graham - often referred to as the "father of value investing". [ 1 ] Published in his book, The Intelligent Investor , Graham devised the formula for lay investors to help them with valuing growth stocks, in vogue at the time of the formula's publication.
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