Fama & French 5-Factor Model

Interpretation

The chart above shows the cumulative performance of the US Fama-French five-factor portfolios, each constructed as a long-short index that compounds monthly factor returns.
Fama and French set out to address a limitation of the Capital Asset Pricing Model (CAPM). CAPM assumes that market risk alone drives expected returns, but it does not explain the persistent outperformance of small-cap and value stocks. Fama and French interpreted these effects as compensation for additional risk rather than simple pricing errors. Their original three-factor model (1993) added size (SMB) and value (HML) alongside market risk (Mkt-RF). In 2015, they extended the framework to five factors by including profitability (RMW) and investment (CMA).
In the historical data, portfolios tilted toward smaller, cheaper, more profitable and conservatively investing companies have earned higher average returns than the broad market.
For interpretation, Aswath Damodaran distinguishes between theoretical models such as CAPM and empirical "proxy" models such as Fama-French. He treats Fama-French as useful for describing realized returns and understanding which characteristics have been rewarded in the past, but is cautious about relying on multi-factor models for forward-looking estimates. For estimating a company's cost of equity, he often still uses the simpler CAPM, while being explicit about its assumptions and limitations.

Data Sources

• Kenneth R. French - Data Library: F-F_Research_Data_5_Factors_2x3 (US equity research factors, monthly returns)

Further Information

• Eugene F. Fama & Kenneth R. French (2015): "A Five-Factor Asset Pricing Model", Journal of Financial Economics.
• Eugene F. Fama & Kenneth R. French (1993): "Common risk factors in the returns on stocks and bonds", Journal of Financial Economics.
• Aswath Damodaran: Riskfree Rates and Equity Risk Premiums (Session 6, lecture).
• Aswath Damodaran (2012): "Equity Risk Premiums (ERP): Determinants, Estimation, and Implications - The 2012 Edition".
• Campbell R. Harvey, Yan Liu, and Heqing Zhu (2016): "... and the Cross-Section of Expected Returns".
• Investopedia: Fama and French Three Factor Model
• Breaking Down Finance: Fama French 5 Factor Model
• LongtermTrends: Factor Investing
• LongtermTrends: Market-Cap Weight vs Equal-Weight
• LongtermTrends: Growth Stocks vs Value Stocks
• LongtermTrends: Large-Cap vs Small-Cap