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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 value fund's excess returns on the three Fama-French factors and finds a significantly positive HML loading and a market-model alpha that becomes statistically insignificant once SMB and HML are added. The most appropriate interpretation is that:

The fund's CAPM alpha was mostly a reward for its value tilt. Once HML and SMB are included, alpha becomes insignificant, so the excess return is explained by factor exposure rather than manager skill.

  1. AThe fund's apparent outperformance under CAPM was largely compensation for exposure to the value factor rather than skillCorrect
  2. BThe fund has no systematic exposure to any risk factor
  3. CThe value factor is irrelevant to the fund's returns
  4. DThe fund manager has demonstrated significant stock-picking skill

Explanation

A positive HML loading means the fund tilts toward high book-to-market stocks. If alpha vanishes once HML is controlled for, the CAPM alpha was explained by factor exposure, not skill. Option D reverses this conclusion.

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