Revaluation Alpha: Why Past Factor Returns May Be Misleading

Robert Arnott, Sina Ehsani, Campbell Harvey, and Omid Shakernia, authors of the September 2025 study “Revaluation Alpha,” examined how much of a factor’s historical returns have been derived from changes in valuation levels (“revaluation alpha”). Their hypothesis was that this return component is typically nonrecurring, making it dangerous to extrapolate historical returns as indicators of future results.

What the Authors Examined

• The authors defined “revaluation return” as the piece of historical return for a factor or strategy that comes from changes in its valuation ratio, rather than from growth in fundamentals.
• They analyzed U.S. stock returns and decomposed the sources of excess returns for 14 common investment factors: accruals, beta, book-to-market, cash flow-to-price, earnings-to-price, idiosyncratic volatility, illiquidity, investments, long-term reversal, momentum, operating profitability, net share issue, size, and short-term reversal.
• They investigated whether the so-called “alpha” from strategies like value investing came from genuine outperformance (structural alpha) or one-time valuation changes (revaluation alpha).

Key Findings

• Revaluation alpha accounted for roughly one-third of the outperformance of stocks over treasury bills.
• For most factors, revaluation effects netted to near zero over very long periods, but in shorter timeframes (even years or a decade), they could dominate performance.

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index.

• The structural premium’s predictive power was strong initially and continued to improve with longer holding periods, reaching its peak at the 6 to 24-month investment horizon.
• Over the short-term (1-12 months) the structural component complemented the predictive power of factor timing signals such as momentum and valuation. However, long-term investors, regardless of whether their goal was to maximize returns or Sharpe ratio, benefited by overweighting the structural component over other signals (especially  momentum).
• Factor and smart beta strategies derived a sizeable chunk of their back tested outperformance from periods when valuations shifted upward. These (often one-off) valuation gains can create an illusion of persistent “alpha”, which likely won’t repeat in the future—indeed, there’s risk it may reverse.

Key Investor Takeaways

• Don’t assume back tested factor “alphas” will repeat: If most of a strategy’s historical return came from rising valuations, future outperformance is unlikely and may reverse.
• Alpha should be decomposed, separating returns due to structural value-add from those due to revaluation.
• Be skeptical of strategies heavily promoted on past “success”—especially if driven by time periods of significant valuation expansion.
• To set forward-looking expectations, focus on fundamental drivers, not just recent returns or back test results.
• The industry (and academia) often overlook or ignore revaluation alpha, which can mislead investors and lead to disappointment because mean-reverting valuation changes are common across factors.
• Performance chasing is perilous: Rising valuations can give the appearance of skill but may simply be non-sustainable price changes.

Conclusion

The core investor lesson: past returns often include non-repeatable revaluation alpha. Since structural alpha is the only component likely to persist, it’s essential for investors to distinguish this from one-off valuation windfalls before placing trust—or capital—in any factor or fund. By focusing on the drivers that endure, investors can avoid the costly trap of misplaced optimism and build portfolios aimed at real, repeated success.

Larry Swedroe is the author or co-author of 18 books on investing, including his latest Enrich Your Future. He is also a consultant to RIAs as an educator on investment strategies.