Momentum Investing

Does time series (intrinsic or absolute) return momentum work everywhere all the time? In their June 2017 paper entitled “A Century of Evidence on Trend-Following Investing”, Brian Hurst, Yao Ooi and Lasse Pedersen investigate the robustness of intrinsic momentum across 67 assets over 137 years. Robustness tests address subperiods, market return/volatility states and economic conditions. They rely mostly on futures prices series but use cash index returns financed at local short-term interest rates when futures data is not available. They consider lookback intervals of one, three and 12 months for momentum measurement. Specifically, they each month:

• Measure for each asset 1-month, 3-month and 12-month past excess returns (relative to the risk-free rate).
• For each lookback interval, take a long (short) position for each asset with a positive (negative) past excess return, scaled to target equal volatility.
• Combine positions across the three lookback intervals and scale the aggregate portfolio to 10% expected annualized volatility (based on rolling 3-year historical windows) for comparability over time.
• Subtract portfolio reformation frictions (based on current and historical estimates) and fees (2% annually plus 20% performance fee above a high-water mark).

Using monthly returns for 67 assets from four classes (29 commodities, 11 equity indexes, 15 bond indexes and 12 currency pairs), along with equity market and economic data used in robustness tests, as available during 1880 through 2016, they find that:

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Is recent Fama-French 5-factor alpha (accounting for market, size, book-to-market, profitability and investment risks) a useful predictor of U.S. equity sector performance? In other words, is there an alpha momentum anomaly at the sector level? In their June 2017 paper entitled “US Sector Rotation with Five-Factor Fama-French Alphas”, Golam Sarwar, Cesario Mateus and Natasa Todorovic examine 5-factor alphas of U.S. equity sectors and test both long-only and long-short sector rotation strategies based on 36-month alpha ranking. They conduct long-sample conceptual tests on 10 Fama-French U.S. sector (or industry) portfolios and short-sample tests on S&P Select Sector SPDR exchange-traded funds (ETF). Specifically, they each month measure rolling alpha for each sector based on the last 36 months of returns, and:

• Long-only strategy – Each month take equal positions in sectors with positive alphas at the end of the prior month.
• Long-short strategy – Each month take equal long (short) positions in sectors with positive (negative) alphas at the end of the prior month.
• Alternative long-only strategy – (1) each month during U.S. economic expansions (per NBER), take equal positions in sectors with positive alphas at the end of the prior month; and, (2) each month during U.S. economic contractions, hold 1-month U.S. Treasury bills (T-bills).

They also compare effectiveness of Fama-French 3-factor model versus 5-factor model for analysis of sector returns. Using monthly returns for Fama-French sectors and factor models, monthly returns for the S&P 500 Index and T-bill yields since January 1964, and monthly returns for sector ETFs since January 1999, all through December 2014, they find that:

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Do stock return momentum and reversal strategies work better when focused on certain intraday intervals rather than close-to-close, according to whether trades are primarily exploiting information or supplying liquidity? In his April 2017 paper entitled “Reversal, Momentum and Intraday Returns”, Haoyu Xu examines intraday versions of momentum and reversal anomalies, with focus on the first two hours and the last two hours of the normal U.S. trading day. He hypothesizes that information-driven trades drive momentum profitability early in the day, and liquidity-driven trades drive reversal profitability late in the day. His anomaly measures are:

• Momentum – (1) sort stocks into tenths (deciles) by cumulative close-to-close or first 2-hour returns over a 6-month ranking interval; (1) skip one month or six months (echo momentum); and, (3) form a portfolio that is long (short) the equally weighted decile with the highest (lowest) past returns; and, (4) hold for one month or six months.
• Reversal – (1) sort stocks into deciles by cumulative close-to-close, first 2-hour or last 2-hour returns over the past month; (2) form a portfolio that is long (short) the equally weighted decile with the lowest (highest) returns; and, (3) hold for one month.

His principal performance metrics are average gross raw monthly return, gross monthly 3-factor alpha (adjusting for market, size and book-to-market), gross monthly 4-factor alpha (adding momentum) and gross monthly 5-factor alpha (adding short-term reversal ). Using daily and intraday prices for a broad sample of U.S. common stocks with prices at least $5 and in the top 90% of NYSE capitalizations during January 1993 through December 2014, he finds that:

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What is the most effective way to hedge against equity market crashes? In their June 2017 paper entitled “The Best Strategies for the Worst Crises”, Michael Cook, Edward Hoyle, Matthew Sargaison, Dan Taylor and Otto Van Hemert examine active and passive strategies with potential to generate positive returns during the worst crises. They test these strategies across the seven S&P 500 Index drawdowns of more than 15% during 1985 through 2016. They focus on two active strategies:

1. Time-series (intrinsic or absolute) momentum long-short portfolio comprised of 50 liquid futures and forwards series spanning currencies, equity indexes, bonds, agricultural products, energy and metals. They consider return lookback intervals of 1, 3 and 12 months. They apply risk adjustments, risk allocations by class and finally a scale factor targeting 10% annualized portfolio volatility. They consider three extensions of the strategy that preclude or restrict positive exposure to equity market beta.
2. Quality factor long-short portfolios comprised of intermediate and large capitalization U.S. stocks. These portfolios ares long (short) the highest-ranked (lowest-ranked) stocks, as selected based on one of 18 metrics representing profitability, growth in profitability, safety and payout. Rankings are risk-adjusted and portfolios are equity market beta-neutral. They again apply a scale factor targeting 10% annualized portfolio volatility. They also consider several composite factor portfolios by averaging individual factor rankings and weighting for dollar neutrality, beta neutrality, sector neutrality and/or volatility balancing.

Using daily data for all indicated assets during 1985 through 2016, they find that: Keep Reading

Does a dual momentum selection/weighting approach applied to the U.S. Treasuries term structure identify a safe haven superior to any one duration? In his February 2015 paper entitled “The Search for Crisis Alpha: Weathering the Storm Using Relative Momentum”, Nathan Faber tests a dual momentum safe haven based on U.S. Treasuries of different durations as proxied by either constant maturity indexes or exchange-traded funds (ETFs). He constructs constant maturity indexes from 1-year, 3-year, 5-year, 7-year, 10-year and 20-year constant maturity U.S. Treasuries yields by each month accruing a coupon and repricing at the new yield. For ETFs, he uses total returns for five iShares U.S. Treasuries ETFs: SHY (1-3 years), IEI (3-5 years), IEF (7-10 years), TLH (10-20 years) and TLT (20+ years). The dual momentum approach consists of the following steps:

1. Calculate the return from 10 months ago to one month ago for each duration.
2. Subtract from the return of each duration that of 1-year U.S. Treasuries (SHY) if using constant maturity indexes (ETFs) to calculate an excess return as a measure of intrinsic (absolute or time series) momentum.
3. Discard any durations with negative excess returns.
4. Rank remaining durations based on risk-adjusted excess returns, with variances used to indicate risk, as a measure of relative momentum and assign weights to these durations based on their ranks. If no durations have positive excess returns, assign 100% weight to 1-year U.S. Treasuries (or SHY if using ETFs).

He then investigates the performance of this dual momentum strategy as a safe haven during S&P 500 crises defined in two ways: (1) drawdowns of at least 20% peak to trough; or, (2) monthly declines of at least 5%. He further tests a specific strategy that is long the S&P 500 Index (or SPY if using ETFs) when above its 10-month SMA (SMA10) and in either the dual momentum safe haven portfolio or in a fixed duration (1-year or 20+ years) when below its SMA10. Using data for the yields/indexes/funds specified above since 1962 for constant maturity index tests and since 2003 for ETF tests, all through 2014, he finds that: Keep Reading

Does average sign of recent returns work as well as recent cumulative return as a momentum metric? In their May 2017 paper entitled “Returns Signal Momentum”, Fotis Papailias, Jiadong Liu and Dimitrios Thomakos introduce and test a momentum strategy (RSM) based on the equally weighted average signs (1 for positive and 0 for negative) of past returns over a given lookback interval. This metric employs each of the past returns during the lookback interval, not a single cumulative return as in times series (intrinsic or absolute) momentum. It considers only signs of past returns, not their magnitudes as in conventional relative momentum. They focus on monthly returns over a lookback interval of 12 months. They test RSM on a universe of 55 of the most liquid futures/forwards: 24 commodities; 9 currency exchange rates versus the U.S. dollar; 9 developed country equity indexes; and, 13 government bonds of various maturities from six developed countries. Their strategy is each month long (short) a contract series when average sign of its last 12 monthly returns is above (below) a threshold. They consider two types of thresholds: (1) fixed over the test period, with the featured optimal value selected by experimentation; and, (2) time-varying, each month choosing the best-performing value (from among 0.2, 0.3, 0.4, 0.5, 0.6, 0.7 and 0.8) over the prior 24 months. Using returns for the 55 futures/forwards series as available to support a strategy test period of January 1985 through March 2015, they find that:
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How well do time series (intrinsic) and cross-sectional (relative) momentum work for different types of currency exchange rates? In their April 2017 paper entitled “Momentum in Traditional and Cryptocurrencies Made Simple”, Janick Rohrbach, Silvan Suremann and Joerg Osterrieder compare the effectiveness of time series and cross-sectional momentum as applied to three groups of currency exchange rates: G10 currencies; non-G10 conventional currencies; and, cryptocurrencies. To measure momentum they employ three pairs (one fast and one slow) of exponential moving averages (EMA) spanning short, intermediate and long horizons. When the fast EMA of a pair is above (below) the slow EMA, the trend is positive (negative). They extract a momentum signal for each exchange rate from these three EMA pairs by:

1. For each EMA pair, taking the difference between the fast and slow EMA.
2. For each EMA pair, dividing the output of step 1 by the standard deviation of the exchange rate over the last three months to scale currency fluctuations to the same magnitude.
3. For each EMA pair, dividing the output of step 2 by its own standard deviation over the last year to suppress series volatility.
4. For each EMA pair, mapping all outputs of step 3 to signals between -1 and 1.
5. Averaging the signals across the three EMA pairs to produce an overall momentum signal.

The time series portfolio holds all currencies weighted each day according to their respective prior-day overall momentum signals.  The cross-sectional portfolio is each day long (short) the three currencies with the highest (lowest) overall momentum signals. Key performance metrics are annualized average gross return, annualized standard deviation of returns, annualized gross Sharpe ratio (assuming risk-free rate 0%) and maximum drawdown. Using daily foreign currency exchange rates for 23 conventional currencies and seven cryptocurrencies versus the U.S. dollar as available through late March 2017, they find that: Keep Reading

Does stock momentum purified of market, size and book-to-market factor risks (idiosyncratic or residual or pure momentum) distinctly outperform conventional momentum? In their April 2017 paper entitled “The Idiosyncratic Momentum Anomaly”, David Blitz, Matthias Hanauer and Milan Vidojevic revisit idiosyncratic past stock return as a return predictor. They specify conventional momentum as total return from 12 months ago to one month ago. To calculate idiosyncratic momentum, for each stock each month they: (1) estimate idiosyncratic return as the part of total return not explained by Fama-French 3-factor (market, size and book-to-market) model betas determined from the prior 36 months; and, (2) calculate idiosyncratic momentum as the volatility-adjusted sum of monthly idiosyncratic returns from 12 months ago to one month ago. They then calculate idiosyncratic momentum factor returns from a monthly reformed hedge (Winners-Minus-Losers, or WML) portfolio that is long big and small stocks with the highest idiosyncratic momentum and short big and small stocks with the lowest. Using monthly stocks/firms data for a broad sample of U.S. common stocks since December 1925, for stocks/firms and currencies in Europe, Asia-Pacific and Japan since January 1989 and for stocks/firms and currencies in emerging markets since January 1992, all through December 2015, they find that: Keep Reading

We developed the Simple Asset Class ETF Momentum Strategy (SACEMS) about six years ago and the Simple Asset Class ETF Value Strategy (SACEVS) about two years ago independently, focusing on the separate logic of asset choices for each. As tested in “SACEMS-SACEVS Mutual Diversification”, these two strategies are mutually diversifying, so combining them works better in some ways than using one or the other. Beginning May 2017, we are making four changes to these strategies for ease of implementation and combination, with modest compromises in logic. Specifically, we are: Keep Reading

Is there an easy way to turn conventional stock momentum crashes into gains? In the March 2017 version of her paper entitled “Dynamic Momentum and Contrarian Trading”, Victoria Dobrynskaya examines the timing of momentum crashes and tests a simple dynamic strategy designed to turn the crashes into gains. This strategy follows a conventional stock momentum strategy most of the time, but flips to a contrarian strategy for three months after each market plunge with a lag of one month. The conventional momentum hedge portfolio is each month long the tenth (decile) or third (tercile), depending on sample breadth, of stocks with the highest cumulative returns from 12 months ago to one month ago and short the tenth or third with the lowest cumulative returns. The contrarian hedge portfolio flips the long and short positions. For her baseline case, she defines a market plunge as a monthly return more than 1.5 standard deviations of monthly returns below the average monthly market return (measured in-sample). For most analyses, she employs the Fama-French U.S. equal-weighted and value-weighted extreme decile momentum hedge portfolios during January 1927 through July 2015. For global developed market analyses, she employs extreme tercile momentum hedge portfolios from various sources during November 1990 through March 2016. She also considers long-only momentum portfolios for emerging markets: one broad during June 1991 through March 2016) and one narrow (Latin American only) during June 1995 through March 2016. Using this data, she finds that: Keep Reading