Two very clever investment strategists at Robeco, an investment firm in the Netherlands, recently published a paper on global tactical sector allocation. They tested relative strength (i.e., momentum in academia) and several other factors to see what worked-and what continued to work after publication. Here’s what they found:
We document significant returns for momentum (1-month and 12-1 month) and the Sell in May seasonal. Interestingly, the predictive power of these factors remains after their publication dates. Although not previously tested for sectors we provide evidence which shows that sectors with positive earnings revisions outperform sectors with negative earnings revisions. We confirm the US findings of Capaul (1999) that valuation, measured as mean-reversion and dividend yield, does not work for global sector allocation. Furthermore, monetary policy fails to predict global sector returns, especially after publication date.
Although it is no surprise to us, relative strength worked in a couple of different formulations, and continued to work after the factors were published. Valuation using mean-reversion and dividend yield did not work, nor did monetary policy. Why does relative strength continue to work when other factors fail? I believe that it is because relative strength is adaptive and does not have catastrophic failures when there is a paradigm shift.
One of the nice things about relative strength is that the factor is so robust it works when measured in many different ways. Our own proprietary RS calculation is the engine behind the Global Macro strategy and the the two Arrow mutual funds that we subadvise.
HT to CXO Advisory.
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