I’m frequently puzzled and bemused by the hostile reception often accorded to relative strength strategies, known as momentum in academia. I saw a classic example recently in a Morningstar article discussing factor loading on various value indexes. In order to determine the value loading, the funds were all subjected to dissection with the Carhart four-factor model. The four-factor model uses regression to determine what the premiums are for size, value, and momentum—above and beyond market return, which is the fourth factor.
There was much discussion about how best to capture the value premium. Included was the following graphic:
Momentum Blindness
Source: Morningstar (click on graph to enlarge)
I swear I am not making this up. As you can see from the graphic, momentum handily outperforms both value and size—and was the only factor to outperform the market. Momentum returns were described as “greed-inspiring and puzzlingly consistent.”
What is puzzling about it? It’s only puzzling if you are working from the assumption that value investing is better than momentum investing, something that is directly contradicted by the data! It’s not just Morningstar that has this bias, by the way. It’s pretty widespread throughout the industry. Relative strength has been a tremendous return factor over time and rarely gets the credit it should be due.
