Factor Investing and the Fama-French Models

Factor investing replaces stock picking with rules. Instead of judging companies one by one, a factor investor ranks every stock in a universe on a characteristic, such as its price relative to book value, and holds the ones that rank best. The approach underlies a large share of quantitative equity management.

Which factors have the strongest evidence?

Value, momentum, size, profitability and low volatility are the most studied. Each has decades of published evidence and each has had long periods of poor returns, value most notably after 2007. The course sets out the evidence for each factor and the competing explanations for why it might persist.

Why are so many published factors false?

Researchers have tested hundreds of characteristics, and some will look significant by chance. Harvey, Liu and Zhu argued that a new factor should clear a much higher statistical bar than the usual one because of this. You will apply that kind of correction to your own results.

How do you test whether a strategy has alpha?

In 1993 Eugene Fama and Kenneth French proposed what is now called the Fama-French model: that two factors, size and value, together with the market, explain most of the differences in average stock returns that the CAPM could not. Their models and methods became the standard way to test whether an investment strategy earns returns beyond known risk factors.

Regress its returns on the factor returns. The intercept is the return the factors do not explain, and the coefficients show the strategy’s exposures. A strategy that looks profitable often turns out to be a mix of known factors. The course shows how to run and interpret that test, and how to test many portfolios jointly with the Gibbons, Ross and Shanken test.

Who is this course for?

Quant equity analysts, portfolio managers and investors who want to understand or build factor strategies.

What you will be able to do

• Define the main equity factors and the evidence behind each.
• Build long-short factor portfolios from company data.
• Measure factor returns, exposures and correlations.
• Combine factors into a multi-factor portfolio and control turnover.
• Apply multiple-testing corrections when judging a new factor.
• Explain the construction of the Fama-French factors and replicate them.

Syllabus, module by module

1. What a factor is

   Characteristics that explain differences in returns; risk and behavioral explanations.

2. The main factors

   Value, momentum, size, quality, profitability and low volatility, with their evidence.

3. Building factor portfolios

   Sorting, ranking, weighting, rebalancing and handling sectors.

4. From CAPM to factors

   The anomalies that the CAPM could not explain, and the response of Fama and French in 1993.

5. Building the factors

   Size and book-to-market sorts, SMB and HML, and replicating them from raw data.

What every course contains

Every paid course comes with the first seven and the certificate, whichever level it sits at. The proctored exam and the credential come when the course is taken as part of a Certificate, Diploma or Fellowship. Everything is self-paced: the material is yours to study in any order, at any hour, for the whole of the license.

1. Workbooks. Written to train the thinking patterns and the important concepts of the course, with worked problems and the reasoning behind each answer, so that you learn to think the way the subject is thought.
2. Audio edition. Focused, well-presented recordings with explainers and examples of the material, made to be interesting, relevant and entertaining, so that the general subject can be learned away from the desk.
3. Notes. Pre-produced notes with every fact the course relies on, written out in full, so that nothing has to be transcribed from the films or the audio.
4. Cheat sheet. One sheet with every important learning concept of the course on it, to keep beside you during the work and to revise from before the exam.
5. Named sources. Every fact in the notes names its source, the paper, the book or the dataset, for anyone who wants to dig in further.
6. Explainer films. Focused films, in the style of the sample films on the catalog page, that walk through the most difficult concepts of the course with visual explanations of a high standard.
7. Transcript. A full transcript of every film and every audio recording, searchable and quotable.
8. Proctored exam. Taken as part of a Certificate, Diploma or Fellowship, the course ends in a proctored multiple-choice questionnaire, with a pass mark of 60% and three retakes included. A course taken on its own is assessed by its coursework and has no exam.
9. Verifiable certificate. A certificate of completion that a third party can verify: an employer sends the code on it to the credentials office and receives written confirmation of the course, the date and the result.
10. Credential of the program. The Certificate, Diploma or Fellowship of the program, track or path the course belongs to, awarded when every course in it is passed. Which one depends on the program you choose.

How the certificate is earned

An assessed project: you construct three factors from company data, test them with costs, combine them into a portfolio, and submit the code with a report. On a pass you receive the Course certificate in Factor Investing and the Fama-French Models, issued by the Institute with a verification code. A course taken as part of a Certificate, Diploma or Fellowship ends in a proctored online exam with a pass mark of 60%. The fee includes three retakes; each attempt after that carries a reduced proctored exam fee. A course taken on its own is assessed by its coursework and has no exam. Read how certification works.

Before you start

This course assumes the material of the courses below, or the same knowledge gained elsewhere.

• Modern Portfolio Theory and the CAPM
• Probability for Quantitative Finance, with Statistics