capm - Intuition behind Fama-French factors

In the Fama-French 3-factor model the portfolio returns are explained by

• the market


• the SMB factor (Small [market capitalization] Minus Big) and


• the HML factor (High [book-to-market ratio] Minus Low) thus "value" minus "growth" stocks.

I know that the factor world has grown by much more factors but for some reason Fama and French have started with these

What is the intuition to use exactly those factors? Which behaviour do we usually expect from these factor? Doesn't small often go hand in hand with growth - would this mean that SMB and HML are (sometimes) negatively correlated?

In (some) booming markets (dot.com bubble) we can expect small companies to outperform large ones - thus SMB should perform positive. In difficult markets companies with a sound basis (high book to market - value) could outperform those with rather high price compared to its book assets (growth) then HML could outperform.

Do these thoughts make sense?

EDIT: 1) Note that factor-investing where portfolios are invested trying to track the factors became popular in recent years. 2) What about the FF-model is true after 2008?

Answer

It is just partial answer to your question.

The Fama and French three factor model can be written as: $$R_{it}=\beta_{im}R_{Mt}+ \beta_{iSMB}SMB_t+\beta_{iHML}HML_t + e_{it}$$ In this model the market index is supposed to capture systematic risk originating from macroeconomic factors. Whereas, SMB and HML are firm specific variables and are chosen because of empirical findings that firm size and book to market ratio predict deviations of average stock returns from levels predicted by CAPM.

Fama and French justified their model on empirical grounds. FF found historical-average returns on stocks of small firms and on stocks with high ratios of book equity to market equity (B/M) are higher than predicted by the security market line of the CAPM. The reason pointed out by FF that firms with high ratios of book-to-market value are more likely to be in financial distress and small stocks may be more sensitive to changes in business conditions and thus provide higher historical-average return than predicted by CAPM.

Beside this you can read paper of Goyal(2012) where author compare the performance of CAPM from FF model. Goyal found clear improvement of FF model over CAPM.