The investment factor captures the tendency for firms with conservative asset growth (low investment) to earn higher average returns than firms that invest aggressively.
Construction
CMA (Conservative Minus Aggressive) is the return on a portfolio of low-investment firms minus a portfolio of high-investment firms. Investment is measured as the annual growth rate of total assets. The factor uses the same 2x3 sort methodology as the other Fama-French factors, with NYSE 30th/70th percentile breakpoints.
Key empirical evidence
- CMA averages 0.33%/month, statistically significant (t>2.3)
- Together with RMW, CMA absorbs the explanatory power of HML, rendering it redundant
Earlier evidence from Titman, Wei, and Xie (2004), Fairfield, Whisenant, and Yohn (2003), and Aharoni, Grundy, and Zeng (2013) documented a weaker but reliable negative relation between investment and average returns.
Theoretical rationale
From the dividend discount model: for fixed values of book equity, market value, and expected earnings, higher expected growth in book equity (investment) implies a lower expected return. Firms that invest aggressively deplete cash flows available to shareholders, reducing the discount rate needed to rationalize their market price.
Alternatively, aggressive investment may signal managerial overconfidence or empire building, leading to poor future returns.
Interaction with size and profitability
The five-factor model’s main weakness involves small stocks that invest heavily despite low profitability. These portfolios produce large negative intercepts (-0.47%/month, t=-5.89), sufficient to reject the model statistically. This pattern does not appear among large stocks.