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what is the reversion factor for quantitative equity portfolio investing
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STRATxAI

February 2024 · 5 min read

Reversion Factor

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Educational

What is the reversion factor ?

The general concept of reversion implies that a trend comes to an end and reverses to some degree. This kind of price action can sometimes occur after recent strong performance - as there are always investors who want to lock-in some profits and so sell their investments.

If this type of profit-taking price action starts to accumulate and other investors follow suit, this can lead to reversion. If for example there is no new fundamental news out to help support the stock, then this profit-taking can cause the stock to fall quite quickly as others panic and sell, as they fear they have missed their profit-taking opportunity.

Reversion is a behavioural factor and therefore is not based or backed up by balance sheet data like for example value or quality. Reversion is a price-based signal and construction methods for it differ from user to user.

Fama-French reversion factor performance

The Fama and French market neutral short-term reversion factor is gross of transaction costs and therefore presents a very optimistic set of results. Reversion in practice is also notorious for being difficult to capture the theoretical results - this is due to missed fills, slippage and trading impact playing a large role. These can be difficult to capture fully in a backtest.

Fama French short-term reversion theoretical factor performance
Fama French short-term reversion theoretical factor performance.
Historical yearly path performance of the reversion factor

If we look at the years in isolation the picture becomes even more rosy and over-optimistic for Fama-French's reversion factor. Apart from the massive drop in performance of the reversion factor after the Fed stimulus package took effect and the bull market returned, the short-term reversion factor has apparently delivered flat to 15% annual returns every year since 2010. Too good to be true it must be said.

Fama French short-term reversion factor yearly performance paths
Fama French short-term reversion factor yearly performance paths.
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