Assignment | Investment Management

Fama-French 1
INVESTMENT MANAGEMENT
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Fama-French 2
Q.1 Fama French’s Findings
Introduction
Asset pricing models keep evolving with new discoveries and advancement in
knowledge. Smart beta, alternative beta or strategic beta is a popular finance concept. Several
risk factors have been used over the years to explain excess returns. The Pricing Model was
developed in the sixties was the first to define risk and its returns by looking at its market
beta exposure. The beta is the metric used to gauge the risk relative to the overall market.
The Fama French model came with value additions like relating momentum to mutual fund
returns. The model still contains irregularities although it gives a good account of average
returns. Furthermore, it does not expound on the small stocks’ low returns despite their
massive investment, a similarity shared with the previous factor models. The exclusion of the
HML value factor records average returns and it captures the five factor model rendering it
redundant. The first Fama French findings were on the association between the portfolio
betas and the average returns (Allen & McAleer, 2018 p.18). Theoretically, there was no
strong upward-sloping association between the portfolio betas and the returns as would have
been expected (Fama & French, 2015 p.10). This led to the conclusion that the CAPM theory
(Barucci & Fontana, 2017 p.458) could not explain average returns well. The second factor
was on size factor, which is the firm’s size measured by market capitalization (Fama &
French, 2015 p.12). Through controlling other factors, Fama-French showed that size is
relative to the firm's profitability (LEONG, 2015 p.33). Since the size is correlated to
information uncertainty that is, smaller firms are not often followed by investments banks
while simultaneously have more volatile fundamentals.
Value factor was also from the Fama-French findings, which was the B-M ratio which
is the ratio of firms’ book value to its present capitalization (Fama & French, 2015 p.13). The
portfolios which had a B-M ratio that was better had returns that were better than average.

Fama-French 3
The Fama-French argued that the positive association of average returns and B-M ratio was
due to better B-M stocks are less profitable and relatively distressed hence firms with this
stocks were riskier and had to have better than average returns.
Profitability factor; the ratio of firms operating profits to book value was also in the
Fama-French findings. They argued that productive firms should have better returns
compared to unproductive firms. Furthermore the better the profitability proved to have better
quality in the firms (Hammond et al., 2015 p.225).
The finding on the investment factor by Fama-French was through ranking and
sorting the firms in quartiles portfolios (Asness et al., 2015 p.37). The conservative levels of
investments had better returns than aggressive firms. A rise in firms’ investments implied that
Lower investment levels were seen to yield better expected earnings when the firms' revenue
was held constant (Gustafsson & Gustavsson, 2019 p.11).
The SMB portfolio catered for size, the HML which handled the B-M factor, the
RMW which handled the factor on profitability and the CMA this handles the investment
spending factor (Anderson, 2016 p.19).
Q.2 ishares Smart Beta Concept
Ishares multifactor EFTs was a combination of size, value, quality, and momentum
factors together encompassing both domestic and international stocks. The multifactor EFTs
that Ishares were considering was capturing three to four factors simultaneously to the new
market. The iShare EFTs were better than the typical multifactor EFTs. The iShare smart beta
constructed was in a different way than the usual smart beta. The iShare smart beta
constructed with the allowance of all factors the size, value, quality and momentum factors
which were developed by the MSCI incorporation which was known for indexes,
performance reporting, and risk management tools (Blitz et al., 2019 p.129). In the creating