If there were two particularly tall parents, should you expect their child to be particularly tall as well? Instinct would say yes, as by nature we tend to assume that that existing trends will continue, but in reality this isn’t the case. Mean reversion suggests that you shouldn’t necessarily expect the child to be as tall as the parents.
Although the parents have passed on their tall genes, they haven’t passed on some of the randomness, some of the epigenetics and other things that can influence a child’s height. Often that random variation gets overlooked, but there’s an important role for both the randomness and the causal aspect of the genetics of height.
Mean reversion can be a difficult concept for people to understand, but it’s a vital consideration in the context of investing, especially as a contrarian investor.
You can learn more about mean reversion in this podcast recorded by Simon Russell of Behavioural Finance Australia, featuring Julian Morrison, our Head of Research Relationships and National Key Accounts. During the podcast Simon and Julian discuss how it can often be uncertainty that leads to mean reversion and as contrarian investors we are looking for that uncertainty, providing we see a brighter future. Listen now.