Redefining multi-factor models for the 21st century

Abstract

The Fama-French 3-factor model started by observing that two types of stocks tend to do better than the market (Small-cap stocks and stocks with high book-to-market ratio). However, we observe that the value stocks have underperformed compared to growth stocks in the last decade. This trend can be cyclical (where value stocks will eventually outperform growth stocks) or a sign of things to come (growth stocks have become intrinsically better due to changes in conducting business in the 21st century). However, we believe that there is a third possible reason- the metrics used to define growth and value stocks under the Fama-French model may no longer be as relevant as they were in the 1990s).