High Minus Low (HML)

What is High Minus Low (HML)?

The term HML stands for High Minus Low is one of the factors of the Fama-French three-factor model. The Fama-French three-factor model is used to evaluate the stock returns through three factors: market risk, SMB and High Minus Low (HML). The High Minus Low is also known as the value premium that shows the spread in returns between the firms that have high book-to-market value ratio and the companies that have a low book-to-market value ratio. The companies with high book-to-market value ratio commonly referred as value stocks outperform the companies with low book-to-market value ratio referred as growth stocks.

Copyright © 2021 Kalkine Media

Understanding High Minus Low (HML)

In order to understand High Minus Low (HML), it is mandatory to have a basic conceptual knowledge about the Fama-French three-factor model first. The Fama-French three-factor model introduced by Eugene Fama and Kenneth French in 1992, the Fama-French three-factor model basically based on the three factors named as market risk, SMB and High Minus Low (HML), and the model is an evolution of the Capital Asset Pricing Model.

The High Minus Low is one of the three factors used in the model to describe the managers’ portfolio’s surplus returns. The model is developed depending on the concept that the returns produced by the portfolio managers are somehow related to the factors, which are uncontrollable for the manager. Primarily, companies with high book-to-market value ratio have historically overweight growth stocks on average, whereas small companies accumulate larger ones.

The first factor outperformance (overweight) of companies with high book-to-market value ratio is mentioned by the term High Minus Low (HML), and the second factor is denoted by the term SMB, stands for Small Minus Big. Through the model, the user can estimate the skills of the manager in a better way by determining the performance of the manager is attributable to the given factors.

If we are talking about the High Minus Low (HML) factors, the model represents whether the managers are depended on the value premium by making the investment in stocks that have high book-to-market ratios in order to generate an abnormal return. Value premium define to the greater risk-adjusted return of the companies with high book-to-market value ratio (value stocks) over the companies with low book-to-market value ratio (growth stocks). If a manager is purchasing only stocks with high book-to-market value ratio, the model regression represents a beneficial (positive) relation to the High Minus Low (HML) factor, which indicates that returns of a portfolio are attributable to the High Minus Low (HML). Because the model generally describes return of the portfolio, the manager’s real extra return falls down.

Frequently Asked Questions (FAQs)

What is the significance of High Minus Low?

High Minus Low (HML) factor shows the spread in returns between the stocks with high book-to-market value ratio and the stocks with low book-to-market value ratio. It represents that stocks with high book-to-market ratios outperform the stocks with those with low book-to-market ratios. High Minus Low (HML) is also known as value premium to the greater risk-adjusted return of the companies with high book-to-market value ratio (value stocks) over the companies with low book-to-market value ratio (growth stocks).

The Fama and French's Three Factor model is principally helping to estimate return of a portfolio manager. A huge excess returns mainly measures’ the better management of the company. The HML factor of the Fama and French's Three Factor model represents that whether a manager is depended on an investment in stocks with high book-to-market ratios (value premium) in order to generate an abnormal return.

In the term High Minus Low (HML), high represents the companies that have a high book value-to-market value ratio whereas, low represents the stocks that have a low book value-to-market value ratio. When evaluating the High Minus Low (HML), a positive beta shows greater sensitivity to high book-to-market stocks and a negative beta shows higher sensitivity to low book-to-market.

What is the mean of HML Beta?

The Fama and French's Three Factor model’s factor High Minus Low (HML) is commonly known as value premium. When the HML factor has been resolute, the beta coefficient of the HML is found by using linear regression. The High Minus Low beta coefficient may show positive or negative values. A positive High Minus Low beta coefficient represents a positive relationship of portfolio to the value premium, and if the High Minus Low beta coefficient is negative, the portfolio of manager acts more like a stock portfolio with low book-to-market value ratio.