Blog - Investing Notes

January 7, 2008 - Combined Value-Momentum Tactical Asset Class Allocation

Are value and momentum anomalies reliably present across international asset classes? If so, can investors exploit them to generate abnormal returns? In the December 2007 version of their paper entitled "Global Tactical Cross-Asset Allocation: Applying Value and Momentum Across Asset Classes", David Blitz and Pim van Vliet examine global tactical asset allocation strategies across a broad range of asset classes based on both value (asset yield or earnings yield) and momentum (both short-term and long-term). These strategies weight asset classes according to volatility, with higher (lower) weights assigned to classes with lower (higher) volatilities. Using price and yield data for 12 international asset classes spanning January 1985 through September 2007, they conclude that:

• Hedge, or zero-investment, portfolios that are long (short) the top (bottom) quarter of asset classes, rebalanced monthly over the entire sample period, generate average annual returns before transaction costs of:
  • 4.4% based on valuation;
  • 5.0% based on 12-1 momentum (calculated from the past 12 months excluding the most recent month); and,
  • 7.4% based on 1-month momentum.
• Correlations among the returns of these strategies are fairly weak (and negative between valuation and the two types of momentum), suggesting distinct effects.
• A hedge portfolio that is long (short) the top (bottom) quarter of asset classes based on a combination of valuation and momentum generates an annualized return of over 9% before transaction costs (perhaps 7% after transaction costs) over the entire sample period.
• Outperformance of this strategy is stable over time and present in a 1974-1985 out-of-sample test on a reduced set of asset classes.
• The return cannot be explained as a reward-for-risk proposition using commonly used risk factors (market, size, value and momentum).
• Financial markets at the asset class level may be inefficient because there is not enough "smart money" to eliminate mispricings.

The following chart, taken from the paper, presents the cumulative performance of the individual and combination hedge portfolios described above. It shows that the performance of the portfolios is generally stable across the entire sample period.

In summary, value and momentum investing may work across a broad range of asset classes, and the two effects are independent enough that combining them may yield incremental outperformance.

For related research, see Blog Synthesis: The Value Premium and Blog Synthesis: Momentum Investing/Trading. See especially the more concentrated momentum-based asset class allocation strategies summarized in our blog entries of 7/27/07 and 2/27/07.