When a mutual fund has persistent demand for a priced factor, the fund needs to rebalance its portfolio’s exposure to that factor as stock characteristics change over time. We establish this behavior of “factor rebalancing” and examine its implications for return predictability. We show that factor rebalancing is prevalent in mutual funds’ holding changes, and this behavior poses a source of predictable price pressure that operates independently from the passive trading induced by retail flows. Consistent with factor rebalancing, stocks whose characteristics are misaligned with underlying funds’ factor demand subsequently have lower returns, while wellaligned stocks subsequently have higher returns. We rule out alternative explanations based on private information, skills, and herding.
RCFS/RAPS Conference at Baha Mar 2019, CICF 2019, SGF 2019, AFA 2021, MFA 2021, NFA 2021, Finance Down Under 2022, SFS Cavalcade North America 2022, FIRS 2022, 10th Helsinki Finance Summit, EFA 2022, Chicago Quantitative Alliance Academic Competition 2022; Birkbeck (University of London), BlackRock, Cambridge, LSE, Notre Dame, Peking University, USI Lugano, Yale SOM
CFAM-ARX Paper Award, Finance Down Under Conference, 2022
Chicago Quantitative Alliance Academic Competition Second Prize, 2022