Factor investing is built on the insight that stock returns are driven by systematic, identifiable characteristics that have delivered excess returns across decades and countries. Fama and French's 1993 three-factor model showed that beyond market risk, size (small stocks outperform large) and value (cheap stocks outperform expensive) explain most cross-sectional return variation. This was extended to five factors adding profitability and investment conservatism. Carhart added momentum in 1997. The revolutionary insight: much of what was attributed to stock-picking skill (alpha) is actually replicable factor exposure (beta). Today, factor-based strategies manage over $2 trillion globally.

The major equity factors each have economic rationale. Value (low P/E, high free cash flow yield) has delivered 3-5% annual premium, compensating for distress risk. Momentum (buying recent winners, shorting losers) has delivered 6-8% annually, attributed to behavioral underreaction then overreaction. Quality (high ROE, stable earnings) outperforms during downturns. Low volatility — the anomalous finding that boring stocks outperform exciting ones risk-adjusted — challenges the assumption that more risk equals more return. Each factor has extended underperformance periods — value suffered a lost decade from 2010-2020 — which is why multi-factor diversification is the institutional standard.

Smart beta ETFs brought factor investing from quant desks to retail portfolios. Traditional cap-weighted indexes like the S&P 500 overweight whatever is most popular and expensive. Smart beta weights stocks by factor scores instead — value ETFs by earnings yield, quality ETFs by ROE. Major providers (iShares QUAL, MTUM, VLUE; Vanguard VFQY) offer single-factor and multi-factor ETFs at 0.12-0.30% expense ratios — far below active management's 1%+ but above vanilla index funds at 0.03%. Smart beta is systematic and rules-based, eliminating style drift and the risk of paying for false alpha.

Implementation requires understanding factor timing, crowding, and interaction. Factor timing — predicting which factors will lead — has an abysmal track record. Evidence strongly favors strategic, diversified multi-factor exposure maintained through cycles. Factor crowding occurs when too much capital piles into the same strategy, compressing the premium and increasing unwind risk. Momentum has the highest turnover and implementation cost. The institutional truth: factor investing works but requires discipline through multi-year drawdowns, humility that factors explain most returns, and sophistication to diversify across factors rather than chase last year's winner.