Shahrin Saaid Shaharuddin, Wee-Yeap Lau, Rubi Ahmad / Journal of Asian Finance, Economics and Business Vol 5 No 4 (2018) 21-34 21 Print ISSN: 2288-4637 / Online ISSN 2288-4645 doi:10.13106/jafeb.2018.vol5.no4.21 Is the Fama French Three-Factor Model Relevant? Evidence from Islamic Unit Trust Funds* Shahrin Saaid Shaharuddin 1 , Wee-Yeap Lau 2 , Rubi Ahmad 3 Received: April 7, 2018 Revised: October 1, 2018 Accepted: October 10, 2018 Abstract The study tests the Fama and French three-factor model by using the newly created Islamic equity style indices. Based on a dataset from May 2006 to April 2011, the three-factor model is tested based on returns of Islamic unit trust funds using the Generalized Method of Moments (GMM) methodology. The sample period is also divided between periods before and after the Global Financial Crisis in August 2008 to test for robustness, and the Bai and Perron (2003) multiple structural break test was used to determine the structural break in the series. The analysis shows that the Fama and French model is valid for Islamic unit trust funds before and after the collapse of Lehman Brothers. The result further indicates the reversal of size effect. As for trading strategies, value funds outperform growth funds by annualized 3.13 percent for the full period. During pre-crisis period, value funds perform better than growth funds while in post-crisis, size factor yields better return than other strategies. As policy suggestion, fund managers need to be aware of the reversal of size effect, and they need to ensure a more transparent stock selection process so that investors can make an informed decision in their asset allocation. Keywords: Unit Trust Funds, Equity Style, Fama and French, Islamic Finance. JEL Classification Code: G11, G12, G14. 1. Introduction 1 Researchers in the area of asset pricing have long accepted the Fama and French three-factor model as an * The earlier version of this paper was presented at the Malaysian Finance Association Conference 2016 and the 7th Islamic Banking, Accounting and Finance Conference 2016. The authors appreciate all comments from the discussants and session chair from the conference as well as the anonymous reviewers. The authors would like to thank the support by the UM-INCEIF Research [grant number MO006-2017]. 1 First Author. Senior Lecturer, Department of Finance and Banking, Faculty of Business and Accountancy, University of Malaya, Malaysia, E-mail: shahrin@um.edu.my 2 Corresponding Author. Associate Professor, Department of Applied Statistics, Faculty of Economics and Administration, University of Malaya, Malaysia [Postal Address: Lembah Pantai, 50603 Kuala Lumpur, Malaysia] Tel: +(60) 3 7967 3747, Fax: +(60) 3 7956 7252, E-mail: wylau@um.edu.my 3 Associate Professor, Department of Finance and Banking, Faculty of Business and Accountancy, University of Malaya, Malaysia, E-mail: rubi@um.edu.my improvement to the Capital Asset Pricing Model (CAPM) which was established by Sharpe (1964) and Lintner (1965). In fact, Fama and French's (1992) finding which has been widely understood to be an advancement to the CAPM model by claiming that beta has little or no ability to explain the cross-sectional variations in equity returns. Researchers argue that the theory should be accepted as a valid theory unless proven otherwise. A limitation to testing the Fama and French three-factor model is difficulties surrounding the nature and construction of the size and book-to-market factors when compared to its simpler counterpart, the Capital Asset Pricing Model (Faff, 2001). However, the tests on the Fama and French three- factor model have been made possible as a result of the creation of off-the-shelf Fama and French factors. Faff (2001) and Long Pham (2007) have been instrumental in proposing methods to examine the validity of the three- factor model by creating and testing the Fama and French factors. Dimson and Marsh (1999) argue that the size premium does not exist in relation to UK firms, especially after periods of recession. Gompers and Metrick (1998), as well