Climateer Investing: It's Anomalous: "Fact, Fiction and Momentum Investing"

Wednesday, January 14, 2015

It's Anomalous: "Fact, Fiction and Momentum Investing"

One of the last remaining anomalies, along with the temperature outside the NYMEX for the natural gas crowd.
From ValueWalk:

Ten Myths About Momentum Investing, Squashed by Tim du Toit, Quant Investing
If you think share price momentum (also called Price Index) is something only traders use and is of no interest to long-term investors (including value investors) then you will definitely find this article of value.
In May 2014 Clifford Asness, Andrea Frazzini, Ronen Israel , (all from ARQ Capital Management) and Tobias Moskowitz from the University of Chicago published a very interesting paper called Fact, Fiction and Momentum Investing.

Momentum 20 years old
The paper clarifies, using already published research studies, the myths that have developed around the concept of momentum since it was first written about in 1993, more than 20 years ago.

What is momentum?
Momentum is the observation that share prices which have performed well (increased more) relative to other share prices (peers) on average continue to outperform, and that prices that have performed relatively poorly (decreased more) tend to continue to underperform.

The word relative is crucial as momentum is calculated by ranking a company’s share price movement against other companies.

For example if you look at 12 months momentum the share with highest (or best) momentum is the one with the largest share price increase over 12 months.

How is it calculated?
In the screener we calculate momentum or Price Index (PI) as (current share price / share price 12 months ago). This allows you to easily and quickly sort companies by share price momentum.
The screener has momentum (or price index) available on all companies from 1 to 60 months for you to use when looking for investment ideas.

Momentum is not trend following
Momentum is often confused with trend following. But trend following is something completely different as shown in the following table.

Source: Fact, Fiction and Momentum Investing

Momentum: History, Data and Methodology
Momentum has been a viable investment strategy for:

US equities for more than 212 years (data since 1802).

It has also been shown to work in 40 other countries

More than a dozen other asset classes like bonds, currencies, commodities and others.

Myths about Momentum Investing
Myth no. 1: Momentum returns are small and sporadic
To see if this myth is true, the authors compared it to the following investment strategies:

RMRF: Equity Risk Premium or the aggregate equity returns minus the risk free rate. This is the percentage the stock market outperformed cash.

SMB: (Small minus Big portfolio) buy small stocks and sell large stocks, – capture the size effect.

HML: (High minus Low portfolio) buy high book-to-price (same as low price to book) stocks and sell low book-to-price stocks, represents value.

UMD: (Up Minus Down portfolio) buy stocks that have high relative one year performance and sell stocks that have low relative one year performance, captures momentum.

The table below shows the return of size, value and momentum strategies. It also shows the Sharpe ratios, a ratio that calculates the performance of an investment by adjusting for its risk.

When comparing the return of different investment strategies the one with a higher Sharpe ratio gives you a better risk adjusted return.

Source: Fact, Fiction and Momentum Investing

Across all three time periods, momentum (UMD) outperformed value (HML) and size (SMB) strategies. Momentum does have higher volatility, but if you look at the risk adjusted returns (Sharpe Ratios), momentum was still the best strategy.

Momentum is not sporadic
The table below shows you if returns from momentum investing are sporadic or not. The table shows the percentage of times each strategy generates positive returns (i.e., the longs beat the shorts, so for value this is how often the cheap stocks beat the expensive stocks, for momentum it’s how often winners beat losers)

Source: Fact, Fiction and Momentum Investing

Momentum best
Over the 36 year period (1927-1963), of you look at 1 year rolling period, momentum is the most consistent, with positive returns 81% of the time as opposed to value, with positive returns 63% of the times....MUCH MORE