Can Momentum Help Active Managers Fight Back Against Passive Strategies?

Today, more investors are pouring cash into passive strategies as they chase lower fees. In September alone, $12.7 billion went into equity passive funds, up from $8.5 billion the previous month.[1] In 2016, a record $287.5 billion was invested in U.S.-listed ETFs.[2] And, in the past decade more than $1 trillion has shifted from active to passive U.S. equity funds.

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In this tough climate for active managers, how can they fight back against passive strategies? It’s simple: outperformance. At Trendrating, we believe managers can intelligently incorporate momentum into the overall strategy, either as a stand alone factor or as an overlay. Momentum brings balance to the Disposition Effect, where human behavior makes investors take profits too early and keep losses longer than necessary. Markets get stretched and are never in equilibrium. Momentum helps cut out the noise. With momentum, there is a clear-cut systematic way to look at the trend. Integrating momentum instills more discipline into any portfolio management system.

Momentum Can Help Active Managers passive strategies passive strategies

Let’s take a closer look at how momentum is put to work as a validation tool. Take for instance, a value manager using momentum in the stock selection process. In our experience, fundamental analysis used with momentum has proven to be one of the best performing strategies. It works because value and momentum are negatively correlated with the result being high returns with low volatility.

Breaking it down further, value managers encounter often a situation where they are considering whether to invest in two separate stocks, A and Z. A is trending up, while Z is trending down. In this scenario, a manager can increase allocation to A displaying positive momentum, while limiting exposure to Z showing negative momentum. When Z turns positive, the manager can increase his/her position. The manager avoids the dilemma of having to own both stocks simultaneously preserving cash and making efficient use of the time horizon.

As a manager using factor investing, momentum can help with tactical allocation in the portfolio. When surveying opportunities in all possible sectors, momentum can identify the highest percentage of companies that show an uptrend in a particular sector. This helps managers focus the portfolio toward a specific sector rather than allocating across multiple lagging sectors.

Accepted as a powerful tool by finance academics, momentum is here to stay and it’s a tactic that active managers can’t afford to ignore. At Trendrating, we recently launched the latest version of our performance management system, 1.7.5. Our self-adjusting model makes it smarter with the ability to quickly identify uptrends and downtrends much earlier than outdated approaches. Managers will have the ability to achieve higher performance on the upside and protect profits on the downside. In the end, we believe Trendrating’s momentum-based performance management system will provide active managers a fighting chance against the wave of passive strategies.

[1] Morningstar Reports U.S. Mutual Fund and ETF Asset Flows for September 2017

[2] ETFs Close Out Year With $2.56 Trillion In Assets, Jan. 03, 2017

Trendrating Op-Ed - By Rocco Pellegrinelli

About the Author

Mr. Pellegrinelli is the Founder & CEO of Trendrating, a global provider of best in class momentum models, analytics and technology. Trendrating’s performance management system is used by over 100 leading asset managers, private banks and wealth managers globally to systematically run multiple portfolio assessments and adjust exposure to capture more trends. Trendrating has a collaboration agreement with FTSE Russell to develop innovative new momentum indexes. The company has offices in London, Boston and Lugano, Switzerland.