This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Fama-French Three Factor Model

3.0 The zero risk return

8.0 The market premium (Beta)

1.0 Size Premium

1.5 Value Premium

The impact of management (Alpha)

Random Error

13.5 Total Expected Return

When a portfolio is measured using this model, the vast majority of returns are explained. Alpha just about completely disappears when a portfolio measurement accounts for the average size and value weights of the holdings. No longer can portfolio managers claim credit for unexplained excess results that occur simply because they held a portfolio tilted toward small or value.

The disappearance of Alpha should bode poorly for the job tenure of active managers. After all, who would pay for excess performance that could simply be obtained by engineering an index portfolio with a strategic tilt toward small or value? In the Air Force we used to joke that there was always that 10% of the troops that didn't get the word. In the investment world, it appears that we have 90% of the troops that haven't gotten the word! Investors continue to pursue active management in spite of the overwhelming evidence that it can't add value consistently. Hope springs eternal, and may trump both common sense and an avalanche of evidence!

Actual results vary depending on timeframe. The various premiums do not show up like clockwork. If they did, they wouldn't be risk factors. There may be long periods where premiums go negative for any or all three factors. For instance, during the period from 1995 to 2000, market premium was huge while small and value premiums were negative. Since 2000 market premium has been negative, while small and value premiums were large. So, the example "tilted" portfolio underperformed the broad domestic market during the first period, and outperformed it during the second. These time frames demonstrate a real world example of tracking error against widely reported indexes even with a superior strategy that paid off over the entire period but that appeared to under-perform during the first half.

While this is part of the normal investment process, short-term experience may obscure the value of a solid long-term strategy. Never the less, over the long haul, each of these factors has been remarkably stable in every economy in the world where we can obtain data, and in every long term time period. So, we have real world evidence coupled with advanced economic theory supporting the existence, persistence and strength of the various premiums.
4 of 5

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $94.19 -1.04%
FB $118.06 0.54%
GOOG $695.70 0.48%
TSLA $222.56 -4.20%
YHOO $36.00 -0.03%


Chart of I:DJI
DOW 17,651.26 -99.65 -0.56%
S&P 500 2,051.12 -12.25 -0.59%
NASDAQ 4,725.6390 -37.5850 -0.79%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs