Mutual funds with persistent demand for a priced factor must rebalance their portfolios as stock characteristics drift over time. We document this behavior, which we term factor rebalancing, and study its implications for asset prices. Focusing on value and momentum, we show that factor rebalancing is prevalent in mutual fund holdings and constitutes a source of predictable price pressure that operates independently of retail flows. Stocks misaligned with their underlying funds’ factor demand subsequently underperform well-aligned stocks by 5–10% per year, with the spread reverting over roughly eight quarters. We formalize the mechanism within a demand framework: because characteristics such as book-to-market and past returns move mechanically with price, growth- and momentum-targeting funds can exhibit upward-sloping demand, and the rest of the market absorbs their correlated trades at a price concession. We rule out alternative explanations based on subsequent fundamentals, skill, 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