By LARRY SWEDROE
Empirical research, including the 2017 paper A Century of Evidence on Trend-Following Investing, has found momentum to be a persistent and pervasive factor in returns of not only stocks but also other asset classes, including bonds, commodities and currencies. Recent empirical research on the momentum factor, including the 2018 studies Factor Momentum Everywhere and Is there Momentum in Factor Premia? Evidence from International Equity Markets, the 2019 studies Factor Momentum and the Momentum Factor and Factor Momentum, and the 2022 study Momentum-Managed Equity Factors, has examined whether momentum can be found in factors as well and found:
- Time-series (trend) factor momentum is a pervasive property of factors — a strategy that buys the recent top-performing factors and sells poor-performing factors achieves significant investment performance above and beyond traditional stock momentum.
- Factor momentum explains all forms of individual stock momentum — stock momentum strategies indirectly time factors; they profit when the factors remain autocorrelated and crash when these autocorrelations break down.
- Demonstrating pervasiveness, factor momentum is a global phenomenon.
- Factor momentum can be captured by trading almost any set of factors.
- Industry momentum stems from factor momentum.
- The value-added induced by factor management via short-term momentum is a robust empirical phenomenon that survives transaction costs and carries over to multifactor portfolios — while managing factors based on last month’s momentum increased turnover, the increase in turnover induced by timing did not outweigh the benefits of timing. In addition, turnover could be reduced using a smoothed version of the timing signal, and timing still yielded significant benefits.
These findings support the conclusion that momentum among equity factors is a pervasive phenomenon in financial markets.
Antoine Falck, Adam Rej and David Thesmar contribute to the momentum literature with their study Is Factor Momentum More than Stock Momentum? published in the December 2021 issue of the Journal of Investment Strategies, in which they investigated the relationship between factor momentum and stock momentum. They analyzed a wide range of definitions of factor momentum using various lags (how many most recent months of data one discards when constructing the signal) and various “holding periods” (number of months of stock returns used to compute momentum). Their data sample was January 1963-April 2014. They restricted their analysis to the 1,000 most liquid stocks on the Center for Research in Security Prices (CRSP) to ensure that the factors trade liquid stocks and have reasonable capacity. Following is a summary of their findings:
- Using a sample of 72 factors documented in the literature, they replicated earlier findings that factor momentum exists and works both directionally and cross-sectionally — an equal-risk average of these factors generated a Sharpe ratio of 0.96.
- Directional factor momentum (time series) was marginally stronger than the cross-sectional implementation, with both strategies generating most of their returns from their long legs.
- Factor momentum was present for a large range of lags and holding periods.
- The average risk-adjusted performance tended to taper off in the late 2000s.
- Controlling for mean factor return, factor momentum was present.
- There was no short-term reversal in factor returns, as at one-month time scales, stocks mean-reverted while factors had persistent returns — a large fraction of the strength of factor momentum comes from the first month, precisely when stock momentum has negative performance.
- Spanning tests revealed that after controlling for stock momentum and factor exposure, statistically significant Sharpe ratios only belong to implementations that include the last month of returns.
Their findings led Falck, Rej and Thesmar to conclude: “Factor returns are persistent at the monthly time scales, while stock returns mean revert. Otherwise, factor momentum is not distinguishable from stock momentum.” Before concluding, we have one more important research finding to discuss.
Mamdouh Medhat and Maik Schmeling, authors of the study Short-term Momentum, published in the March 2022 issue of The Review of Financial Studies (an older version can be found here) contributed to the momentum literature by demonstrating that while, in aggregate, stocks have exhibited negative short-term (one-month) momentum, the well-documented one-month reversal anomaly is fully explained by the negative performance of low turnover stocks—their winner-minus-loser strategy within the highest turnover decile returned 1.37 percent per month (t-stat = 4.74), evidence of strong continuation in one-month returns for high-turnover stocks. Thus, we can conclude that factor momentum and stock momentum in high turnover (the three top deciles of liquidity) stocks has been positively correlated.
There is strong empirical evidence demonstrating that factor momentum provides information on the cross-section of returns and has generated alpha relative to existing asset pricing models. It is for that reason that firms like Alpha Architect and AQR Capital Management, leaders in factor investing strategies, incorporate factor momentum into some of their strategies. For example, AQR recently added cross-sectional stock market factor momentum to their general managed futures strategy. Individual investors can utilise this information without incurring additional costs by incorporating factor momentum into trading decisions. For example, when rebalancing, they can delay purchases of assets with negative factor momentum and delay sales of assets with positive factor momentum.
For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them. The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth® or Buckingham Strategic Partners® , collectively Buckingham Wealth Partners. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article. LSR-22-315
LARRY SWEDROE is Chief Research Officer at Buckingham Strategic Wealth and the author of numerous books on investing.
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