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FRM Part I · FRM Exam Part I · The Arbitrage Pricing Theory and Multifactor Models of Risk and Return

A portfolio manager regresses a fund's monthly excess returns on the Fama-French three factors and obtains an intercept of 0.20% per month, with a market beta of 0.95, SMB loading of 0.60 and HML loading of 0.45. Which interpretation is most appropriate?

The fund is tilted toward small-cap value stocks, since positive SMB and HML loadings indicate size and value exposure. The 0.20% monthly intercept is alpha, the return left after accounting for the three factors' exposures.

  1. AThe fund has a growth tilt because its HML loading is positive
  2. BThe fund is tilted toward small-cap value stocks, and the intercept is the alpha after adjusting for the three factorsCorrect
  3. CThe fund has less systematic risk than the market in every dimension because its market beta is below 1
  4. DThe intercept represents the compensation for bearing size and value risk

Explanation

Positive SMB loading indicates a small-cap tilt and positive HML loading indicates a value tilt. The intercept is the return unexplained by factor exposures, i.e. alpha. A growth tilt would show a negative HML loading, and the size and value premiums are captured by the loadings, not the intercept.

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