Tuesday, March 27, 2018

"Two Centuries of Momentum"

Our five word introduction to last month's "Alice In Factorland: Can Momentum Investing Be Saved?—Arnott et al":
Possibly the last persistent factor.
With a huge hidden risk, see the last link below.
From Flirting With Models:

A momentum-based investing approach can be confusing to investors who are often told that “chasing performance” is a massive mistake and “timing the market” is impossible.
Yet as a systematized strategy, momentum sits upon nearly a quarter century of positive academic evidence and a century of successful empirical results.

Our firm, Newfound Research, was founded in August 2008 to offer research derived from our volatility-adjusted momentum models.  Today, we provide tactically risk-managed investment portfolios using those same models.

Momentum, and particularly time-series momentum, has been in our DNA since day one.
In this Foundational Series piece, we want to explore momentum’s rich history and the academic evidence demonstrating its robustness across asset classes, geographies, and market cycles.

1. What is momentum?
Momentum is a system of investing that buys and sells based upon recent returns.  Momentum investors buy outperforming securities and avoid – or sell short – underperforming ones.

The notion is closely tied to physics.  In physics, momentum is the product of the mass and velocity of an object.  For example, a heavy truck moving at a high speed has large momentum.  To stop the truck, we must apply either a large or a prolonged force against it.

Momentum investors apply a similar notion.  They assume outperforming securities will continue to outperform in absence of significant headwinds.
2. The Two Faces & Many Names of Momentum

2.1 Relative Momentum
The phenomenon of relative momentum is also called cross-sectional momentum and relative strength.

Relative momentum investors compare securities against each other’s performance.  They favor buying outperforming securities and avoiding – or short-selling – underperforming securities.
Long-only relative momentum investors rotate between a subset of holdings within their investable universe. For example, a simple long-only relative strength system example is “best N of.”

At rebalance, this system sells its current holdings and buys the top N performing securities of a basket. In doing so, the strategy seeks to align the portfolio with the best performing securities in hopes they continue to outperform.
2.2 Absolute Momentum
Absolute momentum is also referred to as time-series momentum or trend following.

Absolute momentum investors compare a security against its own historical performance.  The system buys positive returning securities and avoids, or sells short, negative returning securities....
A topic of endless fascination. from the flippant:
Momo Mamas Bored With Dollar, Chasing New Scam Dogs
I'm dating myself.
The headline is a take off on the title of the year 2000 book by Wall Street Journalist John Emshwiller.
To the academic:

Momentum As The Only Reliable Market Anomaly
Whoa! Has The Small-Cap Premium Disappeared? That Would Leave Only Momentum in the Tried-and-True Anomaly File!
UPDATED--Cliff Asness' AQR Capital: A Century of Evidence on Trend-Following Investing; Since 1903
UPDATE--More on "A Century of Evidence on Trend-Following Investing"
AQR Capital's Cliff Asness on Market Efficiency
Attention All Mo-mo Mamas: The Huge Hidden Downside Risk in Momentum Trading
Alpha Persistence & A Simple Momentum System For Beating the Market
The Last Word On Asness' Alpha, Buffet's Beta and The Failure of Commodity Quants (and how to turn hyperlinks into footnotes)
Testing Small-batch Artisanal Portfolio Construction With Cliff Asness and Grantham, Mayo's James Montier
AQR--"Demystifying Managed Futures" (Returns and Anomalies)
Improving on the Four-factor (beta, size, value, momentum) Asset Pricing Model
"Two centuries of trend following"
Because momentum is one of the very few equity market anomalies that holds up under scrutiny, trend following actually does work. And in the case of futures, trend following has become the default quasi-mystical survival strategy for midlevel Commodity Trading Advisors.
(default, dear Brutus, is not in our stars but in ourselves, that we are underlings)... 

The Giant Caveat:
Attention All Mo-Mo Mamas: The Huge Hidden Downside Risk in Momentum Trading
Apparently when issues lose their momo mojo they lose it big.
From Marginal Evolution:
Momentum trading produces outsized losses, paper
Piling in on the hot stock can be all too exciting not just because of the exuberance from outsized gains but also because of the pain of outsized losses such trading strategy can bring and which one of these possibilities happens depends on when such trading strategy is employed, says the latest paper from a triplet of professors.

It has been well documented that price momentum strategy – long position in past winners and an equal short position in past loser – produces outsized gains but based on data from July 1927 to December 2010, authors Kent Daniel, Ravi Jagannathan and Soohun Kim, find that such strategy inflicts staggering losses suggesting that the strategy has a hidden bias in it....