Critical points by Andrew Ang in Asset Management: A Systematic Approach to Factor Investing. Ang makes the comparison between risk factors (like value, low volatility, and momentum) and nutrients in food:
Just as different people have different nutrient needs, different investors have different optimal exposures to the different sets of risk factors…
…There is one difference, however, between factors and nutrients. Nutrients are inherently good for you. Factor risks are bad. It is by enduring these bad experiences that we are rewarded with risk premiums. Each different factor defines a different set of bad times. They can be bad times for investments–periods when the aggregate market or certain investment strategies perform badly. Investors exposed to losses during bad times are compensated by risk premiums in good times. The factor theory of investing specifies different types of underlying factor risk, where each different factor represents a different set of bad times or experiences.
“It is by enduring these bad experiences that we are rewarded with risk premiums.” I think that is a point that is lost on a lot of investors. Many often seek to rotate in and out of momentum based on when the factor is in favor. Market timing factors is pretty tough. I’m not saying it is impossible, but it is definitely pretty tough. Remember, momentum itself is dynamic (as is value and low volatility). If the stocks that a momentum strategy own lose steam, the strategy is designed to rotate out of those stocks and into the new leadership. I think most investors interested in factor investing would be best served by making static allocations to different return factors. Investors could do much worse than a balanced diet of one third momentum, one third value, and one third low volatility with the knowledge that each of these factors will periodically go through rough stretches.
Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. A momentum strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.