Tag: momentum

Global Equities Momentum

Gary Antonacci created the Global Equities Momentum (GEM) model that applied dual momentum to stock and bond indices. It toggles between stocks and bonds using 12-month trailing returns. And when it toggles to “stocks,” it chooses between US equities and International (ex-US) equities based on whichever posted higher returns in the previous 12-months. Newfound Research has a chart that puts it across succinctly:

The model uses the S&P 500 index as a stand-in for US equities and the WORLD ex USA index for international stocks. However, there is nothing in the construction that prevents us from replacing those market-cap based indices with momentum based ones.

US Momentum / Market-cap International

Scenario 1: keep everything the same, except in the last stage, instead of buying S&P 500, buy US Momentum (SP 500×1).
Scenario 2: swap out S&P 500 and put US Momentum everywhere in the decision tree (MOM).

In the cumulative return chart below, the black line is the base case. It represents GEM as originally designed. The red line is Scenario 1 above, green is Scenario 2.
sp500.mom.GEM.cumulative

Even though Scenario 2 has higher returns, it comes at the cost of higher drawdowns. Scenario 1 seems to strike a compromise.
Base case drawdowns:
SP500.GEM.dd
Scenario 1 drawdowns:
SP500x.GEM.dd
Scenario 2 drawdowns:
MTUM.GEM.dd

US Momentum / International Momentum

What if, we bought International Momentum (WORLD ex USA MOMENTUM) instead of the market-cap based WORLD ex USA?
Scenario 3 (dark blue): keep everything the same, except in the last stage, instead of buying S&P 500, buy US Momentum. And instead of buying market-cap international, buy WORLD ex USA MOMENTUM (SP 500×2).
Scenario 4 (light blue): swap out S&P 500 and put US Momentum everywhere. And instead of buying market-cap international, buy WORLD ex USA MOMENTUM (MOMx2).

sp500.mom.world.GEM.cumulative

Scenario 3 drawdowns:
SP500x2.GEM.dd
Scenario 4 drawdowns:
MTUMx2.GEM.dd

Here are returns broken down annually for all the scenarios discussed above:
sp500.mtum.x2.GEM.annual

It appears that using the S&P 500 index for making decisions about buying US vs. World ex-US momentum boosts returns while keeping a floor under drawdowns.

Code and charts are on github.

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MSCI USA Momentum Index

In our previous post, Momentum: Peek under the hood before you invest, we compared a couple of momentum ETFs listed in the US. The most popular one, MTUM, was launched in April 2013. For an investor who is considering it, a five-year sample size is hardly enough. Thankfully, the ETF tracks the MSCI USA Momentum Index. And even though the index itself was launched in February 2013, MSCI has back-filled index levels going back from 1975.

USA Momentum vs. S&P 500 Annual Returns

msci-usa-mom.sp500.annual

USA Momentum vs. S&P 500 Cumulative Returns

msci-usa-mom.sp500.cumulative

It looks like the Momentum Index is highly correlated with the S&P 500 index and for a little bit more volatility, investors end up with quite a bit of excess returns. Does it make sense to swap out the staid old market-cap weighted SPY with MTUM?

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Momentum: Peek under the hood before you invest

Quantitative momentum investing is fairly new in India. To compare different strategies, you need real-world data spanning a complete cycle. The best proxy for this turns out to be US listed ETFs – they have one price (unlike mutual fund share classes) and their adjusted prices can be easily downloaded. Here, we take a look at two momentum ETFs, DWAQ and MTUM, to highlight why investors should go beyond just running a screen for “momentum” and investing in whatever comes up first.

DWAQ vs. QQQ

DWAQ, the Invesco DWA NASDAQ Momentum ETF, was listed back in May 2003. QQQ is a plain vanilla market cap ETF based on the Nasdaq-100 Index. Here are the descriptions from their issuer websites:

The Invesco DWA NASDAQ Momentum ETF is based on the Dorsey Wright® NASDAQ Technical Leaders Index. The Index is comprised of approximately 100 securities from an eligible universe of approximately 1,000 securities of large capitalization companies from the NASDAQ US Benchmark Index. All securities in the universe are ranked using a proprietary relative strength (momentum) measure. Each security’s score is based on intermediate and long-term price movements relative to a representative market benchmark and the other eligible securities. The top 100 securities are selected for the Index. (Invesco)

The Invesco QQQ is an exchange-traded fund based on the Nasdaq-100 Index®. The Index includes 100 of the largest domestic and international nonfinancial companies listed on the Nasdaq Stock Market based on market capitalization. (Invesco)

Here are their relative returns:

Not the torch bearer for momentum that we had hoped for.

MTUM vs. VONE

MTUM, the iShares Edge MSCI USA Momentum Factor ETF, came a good 10 years after DWAQ. Not constrained just to the Nasdaq, it provides wider exposure to large- and mid-cap U.S. stocks exhibiting relatively higher price momentum. (iShares) It is only fair that we compare it to VONE, which is Vanguard’s Russell 1000 ETF. Russell 1000 covers most of the US large- and mid-cap universe. (Vanguard)

Here are their relative returns:

Not bad! That’s almost a 4% difference in annualized returns.

MTUM vs. DWAQ

DWAQ trailed MTUM by about 5% in annualized returns for the period. Probably because it has a more diversified portfolio compared to MTUM’s. This should have lead to shallower drawdowns but that is not the case – DWAQ returns are a lot more volatile than MTUM’s. Will MTUM’s volatility adjusted price momentum continue to out-perform DWAQ’s “proprietary relative strength” momentum? Who knows?

If you think it is a tough job deciding between the two, consider this: there are over 40 momentum ETFs currently listed in the US. Each one slices the data a bit differently, making it absolutely essential that you peek under the hood before you click that buy button!

Charts created using the StockViz Compare Tool.

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Why Anomalies Persist

Academics label momentum as an “anomaly.” Multiple studies have shown that this anomaly has persisted over long periods of time and across markets (AA). Based on this insight, quite a few quantitative momentum funds sprung up. And since nothing good is ever left alone at Wall Street, a whole bunch of momentum factor ETFs launched to ride the wave during the recent bull market. Currently, there are more than 40 momentum ETFs listed in the US.

So, does this mean that the momentum anomaly has been arbitraged out? After all, with over $12 billion in momentum ETFs alone, shouldn’t the strategy have topped out? We posit that it is unlikely to happen anytime soon. Why? Because investors just can’t help themselves.

Consider the asset under management (AUM) of these momentum ETFs. If, for an ETF, the price is down 10% and its AUM is down 20% over the same period, it means that there has been a net outflow of 10%. If you run this math on all the momentum ETFs traded in the US since October this year, you end up with about $2 billion in outflows in 3 months. That is roughly 11.5% of momentum assets on the 1st of October.

It has been well documented that investors chase performance, often piling into “hot” funds and strategies and exiting on the slight whiff of under-performance. We are seeing this in action on momentum ETFs. And as long as investors are caught in this doom-loop, momentum (and by extension, value, investment and volatility anomalies) will persist.

Also read: Investor education is a waste of time (Aug, 2014)

Code and data are on github.

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Momentum, Growth and Market-cap Weighted

Momentum and growth investing are not the same and investing in a market-cap weighted index is not the same as momentum investing.

Momentum Investing

One-liner: A portfolio that is long the stocks that have gone up in price over the last one year will out-perform the market.

There are a number of ways to measure price appreciation. Mainly:

  1. Relative: Compare how price has appreciated in comparison to the market. Rank from largest to smallest.
  2. Absolute: Rank returns from largest to smallest.
  3. Acceleration: Compare how price has appreciated in the last 6-months vs. how price appreciated in the prior 6-month period. Rank from largest to smallest.

The one-year formation period is by no means carved in stone. Some portfolios measure momentum over different time-periods and blend them together.

Additionally, the following preference overlays can be applied:

  1. Stocks with lesser volatility.
  2. Stocks that rise up in price gradually (linear) over ones that have gone up like a hokey stick (parabolic.)
  3. Liquid stocks over illiquid ones to reduce trading frictions.
  4. A trailing stop-loss over strict scheduled rebalancing to manage stock-specific risk.

Growth Investing

One-liner: A portfolio that is long the stocks whose earnings have grown at an above-average rate relative to the market will out-perform the market.

There are number of ways to measure earnings growth. Mainly:

  1. Total sales: Compare this year’s revenue over previous years’.
  2. EBITDA: Compare this year’s operating performance over previous years’.
  3. EPS: Compare this year’s earnings per share over previous years’.

All these measures involve gotchas. For example, any of the following actions taken by the company will boost revenue:

  1. Increase the asset base – setup a new factory.
  2. Increase leverage – take on more debt/buy-back stock.
  3. Compromise on margins – lower prices.

Also, there could be temporary structural shocks – natural disasters/policy shifts – that takes out supply/boosts short-term demand for a company’s/sector’s products.

Market-cap Weighted

One-liner: A committee meets every six months and creates a basket of stocks primarily based on their market cap (number of shares outstanding x price.) This basket defines the market.

Passive investors invest in such a basket through index funds or ETFs and get on with their lives.

The long-arch

All investment strategies have their day/year/decade under the sun and neither are necessarily “better” than the other. It depends on the investor’s task at hand. As an analogy, whether you use a flat-head or a Phillips screw is all nuance when compared to task at hand: screwing. But it is important to know the difference between these investing approaches and not get confused between them.

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