Embracing Multi Factor Theme Based Investing for Diversification

Have you ever heard an orchestra? A group of musicians playing different musical instruments can create a great symphony.

- By: Franklin Templeton Asset Management (India) Pvt. Ltd.

While each instrument plays a different role, the symphony as a whole can be very melodious. What works well in an orchestra, also applies to your investments*. A common phrase associated with investments is - “Do not put all your eggs in the same basket”. This phrase highlights the importance of diversifying your investments to reduce risk. Diversification can be achieved in different ways. The commonly known forms of diversification are across asset classes, sectors, market caps and geographies. However, a lesser-known area is diversification across factors.

What are factors? Factors are characteristics or attributes of securities that help explain their risk and return behaviour. For example, some companies may be relatively more financially stable than their peers. Such companies could have more predictable earnings and cashflows and their stocks may have higher liquidity due to their stable businesses. The common attribute or factor here is quality.

Another factor to look at is value. Some companies may have good business fundamentals and may be trading at relatively lower valuation ratios than the broader market. Such companies have the common attribute of sound businesses with low price to earnings ratio, also called value stocks.