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.