Market Anomalies: Can You Combine Value and Momentum?

From Optimal Momentum:
Value and Momentum Revisited

Most academic research on momentum deals with individual stocks. Most applications of momentum are also oriented toward individual stocks. The three largest publically offered momentum programs (AQR momentum mutual funds, PowerShares DWA Momentum ETFs, and iShares MSCI USA Momentum Factor ETF) all use individual stock momentum. The only widely-available public program using momentum applied to asset classes was the ALPS Goldman Sachs Momentum Builder that recently went out of business due to lack of interest.

Yet momentum applied to individual stocks is not the ideal way to use momentum. Transaction costs due to high turnover of stock portfolios can negate much of the benefit of momentum investing. Momentum applied to broad-based indexes or sectors, on the other hand, can capture high momentum profits with much lower transaction costs.

Here is a table from my new book Dual Momentum Investing: An Innovative Approach to Higher Returns with Less Risk. (The book can be pre-ordered now from Amazon.) This table shows the performance of the AQR Momentum Index composed of the top one-third of the 1000 highest capitalization U.S. stocks based on 12-month relative strength momentum with a one-month lag. AQR weights their index positions based on market capitalization and adjusts the positions quarterly. For comparison, we show the performance of applying absolute momentum to the Russell 1000 index by moving into aggregate bonds whenever 12-month absolute momentum is negative.

Table 9.2 AQR Momentum, Russell 1000, and Absolute Momentum 1980-2013

	AQR Momentum Index[1]	Russell 1000 Index	Russell 1000 w/Abs Momentum
Annual Return	15.14	13.09	15.92
Annual Std Dev	18.27	15.51	12.57
Annual Sharpe	0.51	0.49	0.80
Max Drawdown	-51.02	-51.13	-23.41

These figures do not account for the .7% per year in additional transaction costs for the AQR Momentum Index, would have put it at a disadvantage to even the Russell 1000 index on a risk-adjusted basis. 

The next table shows the AQR Momentum Index, the Russell 1000 Value Index, and a 50/50 combination of value and momentum, which was advocated in the Asness et al. (2013) paper "Value and Momentum Everywhere." This combination is supposed to be desirable due to the negative correlation between value and momentum. We see that value combined with momentum does give a slightly higher Sharpe ratio than either value or momentum alone. However, there is little or no advantage with respect to maximum drawdown, and the results still pale in comparison to simple absolute momentum used with the Russell 1000 Index....MORE

HT: Abnormal Returns

See also:
Whoa! Has The Small-Cap Premium Disappeared? That Would Leave Only Momentum in the Tried-and-True Anomaly File!