In recent years, the investment industry has begun talking about "factors" as a way to beat the market. According to this MSCI paper, there are six "factors": Value, Low size, Low volatility, High yield, Quality and Momentum (I wonder why "Low-cost" was not included). According to MSCI (which provides data for the financial industry): "these factors are grounded in academic research and have solid explanations as to why they historically have provided a premium."
I am skeptical, primarily because nearly all academic research about investing is based on past performance which experienced investors and the government warn us against.
I have also learned from experience (and professor Burton Malkiel) who wrote: "The very popularity of any investment style will sow the seeds of its own destruction." I well remember the industry-promoted popularity of Penny stocks, Day Trading, the "Nifty-Fifty," Dogs of the Dow, IPOs, Commodities, etc..
This 2003 post of mine, containing an article, PREDICTING THE PAST, recalls the "factors" of earlier days.
I am confident that every mutual fund manager knows about "factors" and many managers use them. Nevertheless, the majority of fund managers underperform simple broad market index funds.
A study by Rick Ferri & Alex Benke found that an all index 3-fund market portfolio outperformed active portfolios 82.9% of the time during a 16-year period (1997-2012). That's good enough for me. It also reflects results from The Three-Fund Portfolio forum topic and my book, The Bogleheads' Guide to the Three-Fund Portfolio.
"By and large I do not approve of factor funds." Jack Bogle in Rick Ferri podcast
"As for investment factors, hundreds of strategic-beta funds currently mine those fields. Most of them trail their benchmarks." -- John Rekenthaler, Morningstar Research.
"You don’t need to constantly add new asset classes or investments just because investment firms keep bringing them out. In fact, if you do, you’re more likely to end up with an unwieldy hodge-podge of investments that’s difficult to manage rather than a simpler portfolio that more efficiently balances risk and return." -- Walter Updegrave
The oldest multi-factor fund I could find is PNC Multi-Factor Small-Cap Value C (PSVCX). It's 15-year average return (edited on 8/22/2019) was 4.69%. Meanwhile, Total Stock Market (VTSAX) 15-year average return was 9.14%. A huge difference."Profitable strategies, if they exist at all, do not last for very long. As soon as they are discovered, they are acted upon by the investment community bidding up the price of the relevant assets, thus eliminating their excess return." -- Bill Bernstein in The Intelligent Asset Allocator
AQR is noted for its factor funds. This 2017 study by Tom Allen and Mark Hebner found: "16 funds have under-performed their respective benchmarks since inception and only 8 funds outperformed." One of the reasons is the hidden costs of turnover. Stock turnover averages more than 100%/year in factor funds and less than 5%/year in Vanguard Total Market Index Fund.
Wall Street has a particular fetish for inventing unnecessarily complicated ways of achieving simple goals. Most other professions, so far as I can tell, are more comfortable offering simple ways to do simple things. On Wall Street, complicated ways to do simple things have bigger payoffs — for Wall Street, that is. So complexity proliferates, and it gets encrusted with jargon to impress investors into thinking there’s something special about it. -- Jason Zweig, author and Wall Street Journal columnist
Smart Beta Is Making This Strategist SickVanguard: Factor-based funds are a form of active management. They offer the potential to achieve specific risk and return objectives by purposely and explicitly "tilting" portfolios toward certain stock characteristics, like recent momentum, higher quality, or lower stock prices.
But they come with significantly more risk than you'd experience investing in the broader stock market.
Factor Investing. What Went Wrong?
Edit (1-10-2019): Factor stocks do not add "diversification," they add "concentration" in a particular stock category. In 2018 the U.S. Small-Value category, representing less than 3% of the total market's value, had the WORST 5-year return (-17.03%) of all 14 Morningstar Style Indexes.