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I was wondering whether the famous fama-french factors such as e.g. SMB and HML are market neutral? I know that they are long-short factors in the sense that the net investment is essentially zero, but I was wondering if this also makes them market neutral?

If not, how to make them market neutral?

Bonus: is it also possible to make them beta neutral?

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  • $\begingroup$ Thank you for the reply. The FF factors are not constructed based on a regression though, but rather on those double sorts (first sort stocks on size and then on value), this way essentially creating long-short portfolios. In that case, are they market neutral? $\endgroup$ – Rik Feb 19 at 15:28
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The factors are not constructed to be market neutral. The factors are constructed from 6 subportfolios sorted by book-to-market and size. You can read more about how the factors are constructed at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/f-f_factors.html.

Given that the Fama-French factors are long-short portfolios, it might be reasonable to expect that $\beta_{Mkt}$ for these portfolios would be close to zero. However, the underlying factors may cause significant differences in $\beta_{Mkt}$ for the long and short portfolio. So, for example, small stocks are likely to have a significantly different $\beta_{Mkt}$ to large stocks, and the resultant SMB factor will have an overall $\beta_{Mkt}$.

If you wish to make the resultant portfolios $\beta_{Mkt}$ neutral, you can calculate the $\beta_{Mkt}$ for all of the constituents and reweight the members of each of the 6 subportfolios so that all 6 have a $\beta_{Mkt}$ of 1. There are many ways of doing this if you have access to an optimizer. Any long-short portfolios constructed from those portfolios will then have a $\beta_{Mkt}$ of 0.

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