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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 runs a three-factor regression and finds that a fund has a large positive loading on HML and a negative loading on SMB, with an insignificant alpha. Which interpretation is most appropriate?

The fund tilts toward large-cap value stocks because a positive HML loading signals value and a negative SMB loading signals large caps. With insignificant alpha, its performance is explained by these factor exposures rather than demonstrated manager skill.

  1. AThe fund tilts toward large-cap value stocks, and its returns are explained by factor exposures rather than skillCorrect
  2. BThe fund tilts toward small-cap growth stocks and shows strong manager skill
  3. CThe fund has high market beta and no style tilt
  4. DThe fund tilts toward large-cap growth stocks and has negative alpha

Explanation

Positive HML loading indicates value tilt; negative SMB loading indicates large-cap tilt. An insignificant alpha means returns are explained by these exposures, not by skill. Small-cap growth would have the opposite signs.

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