You are Cristina Vega-Lorenzo, chief investment officer of a pension fund in Madrid. You're about to set the expected return for an equity portfolio tilted toward value and small-cap stocks. CAPM gives you one number; the evidence from recent decades —and firms like Dimensional— say another. Which one do you use to make decisions worth hundreds of millions?
The situation
CAPM says the expected return of an asset is: risk-free rate + β × market premium. With a risk-free rate of 3% and a market premium of 5%, a portfolio with β≈1 "should" return 8% —whether it's value, growth, large-cap, or small-cap makes no difference—. One single factor: the market.
But decades of data show that small and value stocks have persistently returned more than their beta predicts. The multifactor model (Fama-French) captures this by adding two factors: size (SMB) and value (HML). Dimensional Fund Advisors built its business on exactly this. The multifactor model explains what CAPM leaves out —but chasing the maximum tilt assumes those historical premiums will hold forever, and factors can fade.