Momentum, as used by the investing industry, is the tendency for a security to continue to increase (or decrease) in the future if it has performed well (poorly) in the recent past. Research defines “future” to be over the next twelve months. Momentum, as we use it is composed of time-series or absolute momentum and cross-sectional or relative momentum. Readers familiar with the Dual Momentum model know that both cross-sectional and time-series are used to govern security selection. Both absolute and relative momentum principles are used in the Kipling LRPC-BHS model.
With the Kipling spreadsheet we use 60- and 100-trading days as our look-back periods. Numerous calculations go into “divining” the future and the selection of ETFs to populate the investment quiver.
Momentum is the fourth critical factor. We have touched on beta, size, and value. We could stop with a Four-Factor model as these are what I consider the most important factors or market anomalies. The Kipling handles these four very well, provided we populate the investment quiver with ETFs that focus on size and value.
On page 89 of the Berkin-Swedroe book is a persistent table. Readers who use the Kipling spreadsheet will find this of major interest. Remember, the Kipling is definitely a momentum oriented spreadsheet. Quoting from the Factor book we have the following information.
“Over the period from 1927 through 2015, not only has the momentum premium been larger than the United States’ equity premium (9.6 percent versus 8.3 percent), it has also been more persistent.”
Here are the persistent Odds of Outperformance:
- One Year – 73%
- Three Years – 86%
- Five Years – 91%
- Ten Years – 97%
- 20 Years – 100%
Here are more quotes from the momentum factor chapter.
“The authors (referring to a study) also found that while there is a momentum premium in a size groups, the effect is stronger for small stocks, especially micro-caps.”
“While momentum has offered investors the highest risk-adjusted return of all the factors we have discussed, it also has a “dark side” – it has experienced the worst crashes. …two features of the momentum strategy mean it runs the risk of a large loss.” The Kipling is designed to keep losses to a minimum as under-performing ETFs are avoided. In addition, the Kipling includes a worksheet known as the Position Sizing worksheet, a definite help in managing risk averse portfolios.
“Diversification across different factors is a good way to mitigate momentum crashes. For example, because momentum and value are negatively correlated, combining momentum with a value-oriented portfolio has been an effective strategy. Unfortunately, many people have a tendency to look at the performance of individual strategies or factors in isolation, when it is really a strategy’s impact on the overall portfolio that ultimately matters.”
I take issue with the conclusion that “momentum and value are negatively correlated” as I can show this is not the case when working with momentum and value ETFs.
Momentum will continue to play a major role in portfolio management. Pay attention to the Dual Momentum and Buy-Hold-Sell portfolios.