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Factor Investing Faces Ethical and Performance Challenges

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  Published in Stocks and Investing on Sunday, April 5th 2026 at 4:49 GMT by The Globe and Mail
      Locales: CANADA, UNITED STATES

Sunday, April 5th, 2026 - Factor investing, once hailed as a sophisticated route to consistently outperform the market, finds itself at a crossroads. While the strategy's historical track record remains strong, recent performance has been lackluster, and a growing chorus of voices is questioning the ethical implications of profiting from market distress. This confluence of financial underperformance and moral scrutiny presents a significant challenge for investors and a fascinating case study in the evolving landscape of responsible investing.

For those unfamiliar, factor investing is a method of constructing portfolios based on specific, identifiable characteristics - or 'factors' - that have historically been associated with higher returns. Rather than simply mirroring a broad market index like the S&P 500, factor investors actively seek out companies exhibiting traits like value (undervalued based on fundamental metrics), momentum (showing strong upward price trends), quality (possessing robust balance sheets and consistent earnings), and size (typically focusing on smaller capitalization companies). The premise is that these characteristics, by their very nature, will drive superior long-term returns.

A History of Success - Until Recently

For years, the theory held true. Decades of backtesting and live portfolio management demonstrated that factor portfolios, when properly constructed and maintained, consistently beat their benchmarks. This success attracted significant capital, with institutional investors and increasingly, retail investors, allocating funds to factor-based ETFs and mutual funds. However, the past two years have told a different story. 2023 and the first half of 2024 witnessed a significant downturn in the performance of many popular factor strategies. The 'value' factor, in particular, suffered as resilient growth stocks continued to dominate market narratives, and even the 'momentum' factor stumbled as unexpected economic headwinds emerged.

Experts attribute this recent underperformance to a variety of factors. Firstly, a period of prolonged low interest rates diminished the appeal of 'value' stocks, which often shine when rates are rising. Secondly, the unique economic circumstances following the global supply chain disruptions and geopolitical instability created an environment where traditional factor relationships broke down. A crowded trade in certain factors may also have contributed to diminished returns; as more investors piled into these strategies, the 'alpha' - or excess return - became harder to capture.

The Ethical Quandary: Profiting From Pain?

Beyond the financial performance, a more fundamental debate is taking shape. A key criticism leveled against certain factor strategies, particularly those focused on 'value' and 'momentum,' is the potential to benefit from the misfortunes of others. Identifying undervalued companies often means investing in those experiencing financial difficulties. Capitalizing on negative momentum, by its very definition, involves profiting from a stock's decline. This raises legitimate ethical questions: Is it acceptable to actively seek out and profit from corporate distress? Does this contribute to a system where short-term gains are prioritized over long-term sustainability?

"The idea of systematically profiting from struggling companies feels... uncomfortable," says Dr. Eleanor Vance, a professor of behavioral finance at the University of California, Berkeley. "While market forces are amoral, investors have a responsibility to consider the broader implications of their actions. Ignoring the human cost of financial distress is not only ethically questionable but could also ultimately prove unsustainable."

ESG Integration and the Path Forward

Investors are increasingly demanding that their portfolios align with their values. This has led to a surge in interest in Environmental, Social, and Governance (ESG) investing. Some argue that integrating ESG factors into factor strategies can mitigate the ethical concerns. By prioritizing companies with strong ESG scores within a factor framework, investors can potentially achieve both financial returns and positive social impact.

Another approach is active engagement. Investors can use their ownership positions to encourage companies to adopt more responsible practices, rather than simply profiting from their current state. This could involve voting on shareholder resolutions, engaging in dialogue with management, or advocating for policy changes.

The future of factor investing likely hinges on addressing these ethical concerns and demonstrating that profits and principles can coexist. The market is evolving, and investors are becoming increasingly aware of the social impact of their investments. Factor strategies that ignore this trend risk becoming obsolete, while those that embrace a more responsible approach may be well-positioned to thrive in the long run.