Factor Commentary

Three Facts about
Momentum Investing

Andrew Ang |16 jan 2017

Momentum investing is about buying into trends. It is rooted in decades of academic research that shows that securities that have done well in the recent past have tended to perform well in the near future. Over the long run, high momentum securities have tended to drive better returns than the market.

Like all investment factors, non-optimal implementations of momentum strategies can result in poor performance or unintended investment outcomes. In particular, momentum strategies can be vulnerable to painful volatility. Naïve implementations of momentum can exhibit excessive turnover, which can erode alpha through increased tax and transaction costs over time.

Fact #1 Not all trends are equal

While some momentum strategies just focus on a 12-month trend, the magnitude of a six-month trend may be stronger than that of a 12-month trend or vice versa. We believe evaluating stocks based on both a six- and 12-month time horizon can help more consistently capture securities that are continuing to trend and avoid securities which are experiencing a shift in sentiment and reversion in performance.

Fact #2 Momentum shouldn’t mean excessive turnover costs

An excessively short-term view by a momentum strategy can lead to high levels of turnover, boosting transaction costs and tax liabilities. To potentially reduce turnover and minimize transaction costs, a momentum strategy should consider long-term signals, like averaging both six- and 12-month metrics of price momentum. In general, momentum strategies have relatively high levels of turnover, but careful construction rules can keep required trading to a reasonable level.

Fact #3 Opportunistic Rebalancing Matters

In most markets, a semiannual rebalance of the strategy has proven to keep momentum exposures sufficiently fresh. Also, momentum strategies that also provide for off-cycle rebalancing during sudden changes in market environments allows strategies to adjust quickly and can help avoid a potentially painful reversal.