The Five Ws of Style Factors

To explain the intuition and use for five style factors, we tell the story with the five Ws (and one H): who, what, when, where, why and how.

I was a professor for 15 years, and ended my time in academia as Chair of the Finance and Economics Division at Columbia Business School. During my time as an academic, I wrote close to a hundred scientific papers — with technical details that most people would find impenetrable. At the same time, I taught talented MBA students destined for general management, and worked with many non-investment professionals in different types of financial institutions.

These are quite different types of communications and audiences. What is common to the best communication — from technical research to regaling a tale to a friend over a beer — is that we tell a story. And that story must involve answering the five Ws (and one H). To fully understand and develop intuition for the true, underlying explanations, we all need stories.

What factors are and why they have worked

What is a factor? Factors are broad and persistent drivers of return that research has proven to be historically enduring. The most important part of this investment philosophy is why factors have worked and the intuition that drives them. I wrote earlier about the checklist for robust factors, which includes three economic rationales for why they have worked historically:

  1. Rewarded risk - Some factors have earned higher long-term returns as a reward for taking on more risk.
  2. Structural impediment - Market rules or other constraints can place restrictions on certain investors, such as pension funds. Those off-limits investments can become opportunities for others.
  3. Investors’ biases - Over time, opportunities are generated by investors not behaving perfectly rationally. Taking a contrarian view can be beneficial.