Pick up almost any financial magazine or newspaper and you’ll find full-page ads touting the recent performance of mutual funds and ETFs. What’s the reason for their outperformance? The fund companies will give the credit to the genius of the manager, but there’s a way you can tease out a more complete explanation: it’s called factor analysis.

Don’t worry, I’m not going to get all mathy on you—well, maybe a little bit. Performing this kind of analysis is complicated, but understanding the basic ideas doesn’t require a a Ph.D. in statistics. We know investment returns come from exposure to known risk factors (or premiums), and every equity portfolio is exposed to these in varying degrees. What we want to learn is *how much* each factor contributed to the fund’s returns. If the fund outperformed or underperformed its benchmark, factor analysis can tell you why.

Just the factors, ma’am

What are the risk factors? The first is the market premium (or equity premium), which is simply the expected excess return from stocks compared with risk-free investments like T-bills. The second is the value premium: stocks with high book-to-market ratios have historically delivered higher returns than growth stocks.