A version of this article was published in the March 2014 issue of Morningstar ETFInvestor. Download a complimentary copy here.
My colleague Lee Davidson alerted me to an interesting working paper by Eugene Fama and Kenneth French, "A Five-Factor Asset Pricing Model." Fama and French are famous for their three-factor model, which uses market, value, and size characteristics to explain stock returns. The Fama-French model is taken as holy writ by many investors of the passive persuasion, especially advisors who've been through Dimensional Fund Advisors' boot camp. After more than 20 years, Fama and French have embraced the notion that size and value may not be the best factors to explain stock returns. Their new paper, the first draft of which was released in June 2013, finds that two additional factors--profitability and investment--make redundant the value factor. In other words, value stocks--defined as those with low price/book—only beat growth stocks because they historically tended to be more profitable and less voracious users of capital.