In the world of factor investing, industry tilts are often an afterthought. Factor investment strategies systematically target stocks with characteristics that have historically been associated with better risk-adjusted performance. But they often end up with industry weightings that differ from the market's. This article summarizes a study Morningstar conducted to evaluate whether such industry tilts contribute to the success of value, momentum, and low-volatility factor strategies, or whether they are an uncompensated source of risk.

Even if industry tilts contribute to a factor strategy’s outperformance, normalizing factor measures to reflect differences across industries may still make sense. Valuations and accounting practices are more similar within an industry than across industries. For example, technology stocks almost always trade at higher valuations than those in the utilities industry and are generally less asset intensive. In light of these persistent differences, industry-relative factor signals may offer more information about stocks’ future expected returns than unadjusted signals. Substituting larger intra-industry bets for industry tilts may be prudent if intra-industry stock selection offers a more favorable trade-off between active return and active risk (higher information ratio) than industry selection.

Summary
The results of this study suggest that: