We continue our discussion from last week on the topic of mean reversion, this time through the lens of the MSCI Barra US Total Market Equity Trading Model.
MSCI Barra US Total Market Equity Trading Model
MSCI Barra's model has three “flavors” of mean reversion across different time horizons: 1-Day Reversal, Short-Term Reversal, and Long-Term Reversal. This week we’ll go over the basics of these mean reversion factors, and next week we will discuss how to potentially incorporate these factors as a signal to help guide trading.
Short-Term Reversal: the return differences of stocks based on their reversal pattern over the previous month. This factor is the most similar to Axioma’s definition of “Short-Term Momentum” (STM), as discussed in last week’s blog post. Note that in this case assets with the highest exposure to Short-Term Reversal will be assets that have performed the worst over the previous month. This is the equal and opposite definition of Axioma’s STM, and accordingly we see the Short-Term Reversal factor has a long trending upward positive factor return:
Long-Term Reversal: the return differences of stocks based on their reversal pattern over the previous 2 years. This factor is unique from the other reversal factors, as it has two components: Long-term relative strength and Long-term historical alpha. As most of your know, Relative Strength (or RSI) has been used by technical practitioners for decades. On the other hand, historical alpha is interesting because it measures assets that that have dramatically outperformed their peers over the recent 2 years even when removing the market, sector, and all style factors from the return.
Because assets that have outperformed the most will have a positive exposure, the consistently negative factor return will add a drag to performance. We can see that this factor is substantially weaker than the 1-day and short-term reversal, where quantitative strategies tend to be more active.
Preview for next week - how to combine these signals?
MSCI Barra’s three reversion factors are built to be independent of one-another. Thus, the returns you see above are additive and ultimately can be used to create a combined signal that can increase the confidence over detecting the potential mean reversion in an individual security or a basket of securities.
US & Global Market Summary
US Market: 5/11/20 - 5/15/20
Factor Update: Axioma US Equity Risk Model (AXUS4-MH)
Factor Update: Axioma Worldwide Equity Risk Model (AXWW4-MH)
Please let us know if you’d like to better understand and manage your exposure to any of the factors that we’ve discussed.