Cliff Asness new whitepaper Fact, Fiction and Momentum Investing H/T Climateer Investing
It’s been over 20 years since the academic discovery of momentum investing (Jegadeesh and Titman (1993), Asness (1994)), yet much confusion and debate remains regarding its efficacy and its use as a practical investment tool. In some cases “confusion and debate” is us attempting to be polite, as it is near impossible for informed practitioners and academics to still believe some of the myths uttered about momentum — but that impossibility is often belied by real world statements. In this article, we aim to clear up much of the confusion by documenting what we know about momentum and disproving many of the often-repeated myths. We highlight ten myths about momentum and refute them, using results from widely circulated academic papers and analysis from the simplest and best publicly available data.
Momentum is the phenomenon that securities which have performed well relative to peers (winners) on average continue to outperform, and securities that have performed relatively poorly (losers) tend to continue to underperform.2
The existence of momentum is a well-established empirical fact. The return premium is evident in 212 years (yes, this is not a typo, two hundred and twelve years of data from 1801 to 2012) of U.S. equity data,3 dating back to the Victorian age in U.K equity data,4 in over 20 years of out-of-sample evidence from its original discovery, in 40 other countries, and in more than a dozen other asset classes.5 Some of this evidence predates academic research in financial economics, suggesting that the momentum premium has been a part of markets since their very existence, well before researchers studied them as a science.
However, as momentum strategies have grown in popularity, so have myths around them. Some of the most common myths are that momentum is too ?small and sporadic? a factor, works mostly on the short-side, works well only among small stocks and doesn‘t survive trading costs. Furthermore, some argue that momentum is best used as a “screen”, not as a regular factor in an investment process. Others will go so far as to say that momentum investing is like a game of ?hot potato?, implying that it isn‘t a serious investment strategy, with no theory or reasonable explanation to back it up.
Frankly, we‘re a little irked (if that was not clear) by those who should know better but continue to repeat these myths, stretching the limits of credulity. In this essay we address and refute these myths using academic papers (that have been widely circulated throughout the academic and practitioner communities, have been presented and debated at top-level academic seminars and conferences, and have been published in peer-reviewed journals) and the simplest data taken from Kenneth French‘s publicly available website, a standard dataset used by both academics and practitioners. Anyone repeating these myths, in any dimension, after reading this piece is simply ignoring the facts.
2The term ?relative? is important. Momentum is sometimes confused with trend following — though related, these are not the same. The process behind momentum is to rank securities relative to their peers; in contrast, trend following typically focuses on absolute price changes. Unlike trends, which increase exposure during upswings and decrease exposure during downswings, momentum takes no explicit view on the market trend, but simply ranks securities relative to each other over the same time period (though in doing so some implicit, net directional market view may exist). Momentum‘s ?winners? and ?losers? are defined no matter how the market overall is doing. For example, during 2008 a winner would have only been down a few percent relative to other stocks that on average were down more than 30 percent. During market upswings, losers would similarly be defined as stocks that were only up a few percentage points.
3See Geczy and Samonov (2013) for evidence of momentum in U.S. stocks from 1801 to 2012 in what the authors call, with some justifiable pride, ?the world‘s longest backtest?.
4See Chabot, Ghysels, and Jagannathan (2009).
5 See Asness, Moskowitz and Pedersen (2013).
Please note, of course, that we make no claim that momentum works all the time. In fact, of late (this year and the last few years), momentum as a strategy has had a more difficult time. Still, the fact is momentum is a risky variable factor (as they all are) with an impressive long-term average return that survives all the attacks (myths) hurled against it. In this essay, we defend momentum, including its use stand-alone (especially as a substitute for growth investing) and in combination with value, from these persistent attacks. We feel this, both myth busting and focusing on the long term, is especially important given momentum’s recent performance which only wrongly reinforces the resilience of its attackers. At the same time, our goal is not to denigrate other factors, most specifically value. Although we occasionally note the irony that many of the myths we dispel come from value investors attempting to discredit momentum, even though several of these myths actually apply better to value investing itself! However, as we‘ll show in this essay, value and momentum work better when used as complements, and it is the combination of the two we stress and most-strongly recommend. We are fans of both momentum and value but bigger fans of their combination (and not fans of myths at all).
Now, on to the myth busting.
Myth #1: Momentum returns are too “small and sporadic”.
While we have already cited some evidence in the introduction, given this precisely worded myth has been used in print, a further exploration of this most basic issue has to be myth #1. We start with gross of costs, long-short portfolios to establish base-line results. In later sections we debunk the myths surrounding shorting, transactions costs, and the general implementability of momentum for traditional long-only investors.
Momentum‘s presence and robustness are remarkably stable (and by this we don‘t mean that it doesn‘t have long stretches of poor performance, as does any factor, or short stretches of extreme performance; we mean the overall evidence across very long periods of time and in many places). Again, it is present in U.S. stocks over very long time periods and following its academic ?discovery? in the early 1990s, has been shown to be robust out-of-sample (an important exercise we will repeat here), in the individual stocks of other countries, for stock markets, and for completely different asset classes, such as bond markets, currencies, commodities, and others. It has become one of the preeminent empirical regularities studied by academics and practitioners. To see why we will provide evidence that anyone can replicate. Most of the analysis is based on factors from Professor Kenneth French‘s website and focuses on momentum within U.S. stocks. Some definitions are needed and we follow Professor French here:
- RMRF represents the equity market risk premium, or aggregate equity return minus therisk free rate. It is the return from simply being long equities at market capitalization weights and, unlike the other factors, is not a ?spread? return between one set of stocks and another but between all stocks and cash;