The range of factors is broad. Take calendar effects, where the “sell in May…” rule is only one of a number of seasonal factors. There’s also the Santa Claus rally, where equities tend to surge in the week after Christmas and into the start of the new year, not to mention quarter-end and turn-of-month effects that have variously been identified.2
Investment professionals, however, tend most often to focus on five key factors [see chart above for examples].
Size: in the early 1980s, Rolf Banz, long associated with Pictet Asset Management, analysed and described a relationship between companies’ market capitalisations and their risk adjusted returns. Over time, he found that smaller companies tended to outperform. This may be down to liquidity effects – investors demand more premium from shares that, potentially, they can’t easily sell. Or it may be down to the fact that smaller companies are less researched, creating inefficiency that investors can take advantage of.
Valuation: companies whose shares trade on lower price-to-earnings multiples, or price-to-book ratios, tend to outperform over the very long run. One argument for this is that over shorter periods market noise can mask firm's intrinsic value, but that eventually shares will revert to the correct price. However, this sort of mis-pricing can last a long time. In the 10 years since the global financial crisis, growth stocks have outpaced their value equivalents. It could take a recession for this to reverse.3
Momentum: the tendency for stocks that are enjoying a strong run to continue this into the future. Under a momentum strategy, investors increase their allocation to stocks or bonds that have been rising in price, and cut holdings of those that are dropping. Momentum has historically tended to be a particularly effective investment approach, though getting caught out on big market turning points can be painful.
Quality: companies with strong profit margins and significant market share tend to outperform over the long run. Quality is similar to valuation, and has similar drawbacks. Stock markets can under-appreciate good quality companies for uncomfortably long stretches.
Volatility: portfolios composed of stocks that are less volatile than average tend to generate better returns over time than those composed of shares that see big price swings. Generally, investors would expect to be compensated for risk – for which volatility is a proxy. Evidence, however, suggests the opposite.