Momentum: “A Powerful Way To Enhance Returns”

Morningstar does a pretty deep dive into momentum in their article Does Momentum Investing Work?  I highly recommend reading the whole article as it covers some excellent long-term studies of momentum.  It also has a nice profile of our PowerShares DWA Technical Leaders ETF (PDP).

While practitioners have been exploiting this relationship for decades, the idea has gained broad acceptance in the academic community only within the past 20 years. Momentum runs counter to the predictions of the efficient market hypothesis, but the evidence is too overwhelming to ignore.

Included in their article was the following study of momentum on U.S. and global stocks:

The tables below illustrate the momentum effect among large-cap U.S. and global stocks. Each column represents a fifth of the total number of stocks in the sample, which are ranked by their momentum. While there is not a linear relationship between the momentum quintiles, stocks with the highest momentum consistently outperform those in the lowest momentum quintile. Small-cap stocks tend to exhibit a stronger momentum effect. However, they can be more expensive to trade.

french

I also enjoyed this part about how the persistence of excess returns from momentum strategies continues to baffle people:

This evidence creates a puzzle. If the market were efficient, a simple trading rule should not produce superior returns. Arbitrage is a powerful force that should eliminate any excess profits, and yet, momentum has persisted 20 years after it was first widely published. Perhaps more troubling to disciples of Ben Graham and Warren Buffett, momentum appears to be at odds with decades of research, which suggest that stocks trading at low valuations tend to outperform.

The article also makes a strong case for why momentum makes a better companion for value than does growth:

In their paper, “Value and Momentum Everywhere,” Asness, Moskowitz, and Pedersen found that momentum worked well when value didn’t, and vice versa. Because they are two sides of the same coin, each with excess returns, combining value and momentum in a portfolio can offer powerful diversification benefits.

It’s not necessary, or advisable, to abandon value investing to benefit from momentum. Instead, momentum may be a good substitute for investors’ growth allocations. Momentum offers higher expected returns than growth and tends to be less correlated with value. The chart below compares the performance of a portfolio consisting equal weights in the Russell 1000 Value and Growth indexes, with a portfolio that replaces the growth allocation with the AQR Momentum Index. The two portfolios have similar volatility, but the value and momentum portfolio offers slightly better absolute and risk-adjusted returns.

momentum_value

Finally, I agree with Morningstar’s assessment of why the excess returns from momentum are likely to persist:

While a diversified and systematic momentum strategy can offer a powerful way to enhance returns, selecting a few stocks on the 52-week high list is a very bad idea. It is difficult to anticipate when a run will end and there may be no greater fool to bail you out. Although momentum is a short-term phenomenon, it is best suited for long-term investors. It won’t always work, but there’s a good chance that a disciplined momentum strategy will continue to outperform over the long term. After all, investor behavior won’t change overnight.

HT: Abnormal Returns

4 Responses to Momentum: “A Powerful Way To Enhance Returns”

  1. Economiquement aussi, la technologie tombe

  2. Toms Salg says:

    At present, Momentum: “A Powerful Way To Enhance Returns” • Systematic Relative Strength • Dorsey Wright Money Management Systematic Relative Strength environmental situation is more serious,Toms Salg long-term environmental concerns had not been resolved,Toms Salg new environmental problems were being made. Report of the party’s 18 proposed the Toms Salg construction of ecological civilization of socialism,Toms Salg general arrangement to expand construction of socialism with Chinese characteristics for the five-in-one, which refers to new heights to protect the environment. Implement the spirit,Toms Salg solving environmental protection problem, you must correctly handle the relationship between economic development and environmental protection,Toms Salg firmly establish the ecological environmental protection is to protect productivity,Toms Salg improvement of the ecological environment is developing the concept of productivity,Toms Salg economic development and environmental protection complement each other.

  3. dating women says:

    If you desire to increase your experience just keep visiting this web page and be updated with the latest news posted here.

  4. Howdy I am so excited I found your weblog, I really
    found you by accident, while I was looking on Digg for something else,
    Anyhow I am here now and would just like to say thanks a lot for a marvelous post
    and a all round interesting blog (I also love the theme/design), I don’t have time to read through it
    all at the moment but I have book-marked it and also added in your
    RSS feeds, so when I have time I will be back to read much more, Please do
    keep up the great b.