Abstract

We define revaluation return as the portion of a factor's historical return that comes from changes in its valuation ratio. A factor may have impressive historical performance, but if the high return was driven by rising valuations, it is likely unwise to expect similar future returns because valuation ratios cannot rise indefinitely, and often mean-revert. We define structural return as the historical factor return net of the revaluation return. For decades, the factor literature has implicitly assumed that revaluation alpha is equally predictive to structural alpha. We challenge that assumption. Structural returns predict future returns better than raw historical returns and add incremental value beyond well-known timing signals such as momentum.