Momentum Investing

What is the right balance between seeking alpha and avoiding taxes? In their August 2023 paper entitled “Alpha Now, Taxes Later: Tax-Efficient Long-Only Factor Investing”, Yin Chen and Roni Israelov assess trade-offs between rebalancing benefits and tax avoidance from overlapping 10-year backtests of long-only momentum, value, quality and safety factor stock portfolios. They measure momentum as cumulative return from 12 months ago to one month ago, value as book-to-market ratio, quality as operating profitability and safety as winsorized market betas. All portfolios start with the equal-weighted top fifth (300 stocks) as ranked by the factor metric. After initial formation, they consider five monthly portfolio management rules:

1. Fully Rebalanced, each month selling stocks that drop out of the top fifth and buying stocks that enter the top fifth, but not adjusting weights of stocks that remain in the portfolio.
2. Buy-and-Hold (no rebalancing over the 10-year portfolio life).
3. Sell Losers at Losses, each month selling stocks that have migrated to the bottom fifth if they have capital losses.
4. Tax Loss Harvesting, each month selling stocks with more than 5% unrealized losses and not buying them back until at least 30 days later.
5. Tax Loss Harvesting and Sell Losers, selling stocks that have migrated to the bottom fifth even if they have unrealized capital gains so long as the aggregate realized capital gain is zero.

They form the first portfolio for each factor in June 1964 and initiate new portfolios every six months until January 2012, such that the last portfolio is held through December 2021. They focus on 1-factor (market) alpha, averaged across overlapping portfolios, as the key performance metric. To calculate net performance, they assume 0.08% 1-way trading frictions, 23.8% dividend tax rate and 23.8% (40.8%) long-term (short-term) capital gain tax rate. Based on initial findings, they repeat all tests on composite portfolios of value, quality and safety factors constructed by ranking stocks on individual factors and investing equally in the fifth of stocks with the highest combined rankings. Using data as specified for the 1,500 U.S. stocks with the largest market capitalizations at the end of each prior year during 1964 to 2021, they find that:

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Are the “Simple Asset Class ETF Value Strategy” (SACEVS) and the “Simple Asset Class ETF Momentum Strategy” (SACEMS) mutually diversifying. To check, based on feedback from subscribers about combinations of interest, we look at three equal-weighted (50-50) combinations of the two strategies, rebalanced monthly:

1. 50-50 Best Value – EW Top 2: SACEVS Best Value paired with SACEMS Equally Weighted (EW) Top 2 (aggressive value and somewhat aggressive momentum).
2. 50-50 Best Value – EW Top 3: SACEVS Best Value paired with SACEMS EW Top 3 (aggressive value and diversified momentum).
3. 50-50 Weighted – EW Top 3: SACEVS Weighted paired with SACEMS EW Top 3 (diversified value and diversified momentum).

We consider as a benchmark a simple technical strategy (SPY:SMA10) that holds SPDR S&P 500 ETF Trust (SPY) when the S&P 500 Index is above its 10-month simple moving average and 3-month U.S. Treasury bills (Cash, or T-bills) when below. We also test sensitivity of results to deviating from equal SACEVS-SACEMS weights. Using monthly gross returns for SACEVS, SACEMS, SPY and T-bills during July 2006 through July 2023, we find that: Keep Reading

Does adding an exchange-traded fund (ETF) or note (ETN) to the Simple Asset Class ETF Momentum Strategy (SACEMS) boost performance via consideration of more trending/diversifying options? To investigate, we add the following 25 ETF/ETN asset class proxies one at a time to the base set and measure effects on the Top 1, equally weighted (EW) Top 2 and EW Top 3 SACEMS portfolios:

JPMorgan Alerian MLP Index (AMJ)
VanEck Vectors BDC Income (BIZD)
Vanguard Total Bond Market (BND)
SPDR Barclays International Treasury Bond (BWX)
Invesco DB Agriculture Fund (DBA)
iShares MSCI Emerging Markets (EEM)
iShares MSCI Frontier 100 (FM)
First Trust US IPO Index (FPX)
iShares iBoxx High-Yield Corporate Bond (HYG)
iShares 7-10 Year Treasury Bond (IEF)
iShares Latin America 40 (ILF)
iShares National Muni Bond ETF (MUB)
Invesco Closed-End Fund Income Composite (PCEF)
Invesco Global Listed Private Equity (PSP)
IQ Hedge Multi-Strategy Tracker (QAI)
Invesco QQQ Trust (QQQ)
SPDR Dow Jones International Real Estate (RWX)
ProShares UltraShort S&P 500 (SDS)
iShares Short Treasury Bond (SHV)
ProShares Short 20+ Year Treasury (TBF)
iShares TIPS Bond (TIP)
United States Oil (USO)
Invesco DB US Dollar Index Bullish Fund (UUP)
ProShares VIX Short-Term Futures (VIXY)
ProShares VIX Mid-Term Futures (VIXM)

We focus on gross compound annual growth rate (CAGR) and gross maximum drawdown (MaxDD) as key performance statistics, ignoring monthly reformation costs. Using end-of-month, dividend-adjusted returns for all assets as available during February 2006 through June 2023, we find that: Keep Reading

Are all of the potentially trending/diversifying asset class proxies used in the Simple Asset Class ETF Momentum Strategy (SACEMS) necessary? Might one or more of them actually be harmful to performance? To investigate, we each month rank the nine SACEMS assets based on past return with one excluded (nine separate test series) and reform the Top 1, equally weighted (EW) Top 2 and EW Top 3 SACEMS portfolios. We focus on gross compound annual growth rate (CAGR) and gross maximum drawdown (MaxDD) as key performance statistics, ignoring monthly portfolio reformation costs. Using end-of-month, dividend-adjusted returns for SACEMS assets during February 2006 through June 2023, we find that: Keep Reading

A subscriber asked about the stability of the momentum measurement (lookback) interval used for strategies like the Simple Asset Class ETF Momentum Strategy (SACEMS). To investigate, we run two tests on each of top one (Top 1),  equal-weighted top two (EW Top 2) and equal-weighted top three (EW Top 3) versions of SACEMS:

1. Identify the SACEMS lookback interval with the highest gross compound annual growth rate (CAGR) for a sample starting February 2006 when Invesco DB Commodity Index Tracking Fund (DBC) becomes available and ending each of May 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019, 2020, 2021, 2022 and 2023. We consider lookback intervals of one to 12 months, meaning that earliest allocations are for February 2007 to accommodate the longest interval. The shortest sample period is therefore 5.3 years. This test takes the perspective of an investor who devises SACEMS in May 2012 and each year adds 12 months of data and checks whether the optimal lookback interval has changed.
2. Identify the SACEMS lookback interval with the highest gross CAGR for a sample ending May 2021 and starting each of February 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 and 2018. The shortest sample period is again 5.3 years. This test takes perspectives of different investors who devise SACEMS at the end of February in different years.

Using monthly SACEMS inputs and the SACEMS model as currently specified for February 2006 through May 2023, we find that: Keep Reading

Instead of searching among hundreds of firm/stock characteristics to identify those that best predict stock returns, what about first finding the stocks with the highest and lowest past returns and then examining the characteristics of those stocks? In his June 2023 paper entitled “Essence of the Cross Section”, Sina Seyfi identifies the strongest determinants of expected stock returns by:

1. Sorting stocks into fifths (quintiles) at the end of each month during the last 10 years based on monthly returns (120 sets of quintile portfolios).
2. Computing the average monthly value of each of 206 firm/stock characteristics among stocks in each quintile across the last 10 years.
3. Forming each month out-of-sample quintiles that are as similar as possible regarding these 206 average characteristics to the in-sample returns-sorted quintiles.
4. Studying variations of the 206 characteristics across these out-of-sample quintiles to identify the most important drivers of future stock returns.

This method allows for non-linearities and interactions among characteristics, which a conventional linear regression method does not. Using returns and characteristics data for publicly listed U.S. common stocks and the U.S. risk-free rate as available during 1926 through 2021, he finds that:

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What characteristics of U.S. equity factor return series are most relevant to respective factor performance? In his May 2023 paper entitled “The Cross-Section of Factor Returns” David Blitz explores long-term average returns and market alphas, 60-month market betas and factor performance cyclicality for U.S. equity factors. He also assesses potentials of three factor rotation strategies: low-beta, seasonal and return momentum. Using monthly returns for 153 published U.S. equity market factors, classified statistically into 13 groups, during July 1963 through December 2021, he finds that:

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Why is trend following so persistently popular among investors? In their March 2022 paper entitled “A Guide to Trend Following Strategies”, Stuart Broadfoot and Daniel Leveau describe popular trend identification methods and provide an example of how to build/test a multi-asset class trend following strategy in four steps. Using trend following index data during January 2000 through May 2022 and prices for 52 futures contract series during January 2000 through January 2022, they find that: Keep Reading

Are stock and sector momentum strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider nine momentum-oriented equity ETFs, all currently available, in order of longest to shortest available histories:

• Invesco DWA Momentum Portfolio (PDP) – invests at least 90% of assets in approximately 100 U.S. common stocks per a proprietary methodology designed to identify powerful relative strength characteristics, reformed quarterly. Benchmark is iShares Russell 3000 (IWV).
• Invesco DWA SmallCap Momentum (DWAS) – invests at least 90% of assets in approximately 200 small-capitalization U.S. common stocks per a proprietary methodology designed to identify powerful relative strength characteristics, reformed quarterly. Benchmark is iShares Russell 2000 (IWM).
• iShares Edge MSCI USA Momentum Factor (MTUM) – holds U.S. large-capitalization and mid-capitalization stocks with relatively high momentum. Benchmark is iShares Russell 1000 (IWB).
• First Trust Dorsey Wright Focus 5 (FV) – holds five equally weighted sector and industry ETFs selected via a proprietary relative strength methodology, reformed twice a month. Benchmark is IWV.
• iShares MSCI Intl Momentum Factor (IMTM) – holds international developed market large-capitalization and mid-capitalization stocks with relatively high momentum. Benchmark is iShares MSCI ACWI ex U.S. (ACWX).
• SPDR Russell 1000 Momentum Focus (ONEO) – tracks the Russell 1000 Momentum Focused Factor Index, picking U.S. stocks that have recently outperformed. Benchmark is IWB.
• Alpha Architect U.S. Quantitative Momentum (QMOM) – seeks to buy stocks with the highest quality momentum via a portfolio that generally holds 50 stocks. Benchmark is IWV.
• First Trust Dorsey Wright Dynamic Focus 5 (FVC) – similar to FV but with added risk management via an increasing allocation to cash equivalents when relative strengths of more than one-third of the universe diminish relative to a cash index, reformed twice a month. Benchmark is IWV.
• JPMorgan U.S. Momentum Factor (JMOM) – holds U.S. common stocks with strong risk-adjusted momentum. Benchmark is IWB.

We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). We assign broad market benchmark ETFs according to momentum fund descriptions. Using monthly dividend-adjusted returns for the nine momentum funds and respective benchmarks as available through April 2023, we find that: Keep Reading

A subscriber asked about the performance of a variation of the monthly reformed 50-50  Simple Asset Class ETF Value Strategy (SACEVS) Best Value-Simple Asset Class ETF Momentum Strategy (SACEMS) Equal-Weighted (EW) Top 2 combination that substitutes 100% SACEMS EW Top 2 whenever both:

1. SPDR S&P 500 ETF Trust (SPY) is the selection for SACEVS Best Value at the end of the prior month.
2. SPY is below its 10-month simple moving average at the end of the prior month.

The objective of the variation is to suppress SACEVS Best Value drawdowns. To investigate, we compare performance results for this variation (“Filtered”) with those for baseline 50-50 SACEVS Best Value-SACEMS EW Top 2. Using monthly returns for SACEVS Best Value and SACEMS EW Top 2 since July 2006 (limited by SACEMS) and monthly dividend-adjusted prices for SPY since September 2005, all through March 2023, we find that: Keep Reading