Equity reversal is a winner-loser trade strategy that sells weekly outperformers and buys underperformers. Equity reversal has been seen to be a profitable approach for investors and could offer a real opportunity for investors looking to enhance the risk-return profile of their equity portfolio. BNP Paribas’ QIS Lab proposes a new explanation for such contrarian profits, a long hotly debated topic.
Relevant for asset managers and asset owners specialising in equities or liquid alternative portfolios, this study investigates a strategy whose risk profile diverges sharply from that of financial assets. Equity reversal is an alternative risk premium strategy with a distribution of returns that can be sharply skewed to the upside. The research touches on systemic risk vs issuer specific risk and it compares intraday data to weekly data, which is a new approach to this analysis.
This deep dive into contrarian investing shows that although the strategy can be negatively impacted when share prices move in a straight line, the risk can be mitigated by leaving out shares with the highest level of uncertainty and by controlling sector and factor exposure. The authors also demonstrate how an existing equity portfolio can be diversified into equity reversal in order to improve the return-to-risk ratio.
The paper, called ‘Against the grain’, enhances our understanding of mechanisms that generate contrarian profits. This is a useful contribution to highlight an area of potential opportunity for investors who are looking to upgrade the risk-return profile of their equity portfolio.