The Journal Round-Up of November 11, 2013 from Nomura Quantitative Strategy has a section that focuses on academic papers on cross-asset tactical allocation.

The subject has assumed importance given the rapid growth seen in the AUM of multi-asset funds. The academic papers are grouped under the heads Value, Technical/momentum, Value and momentum, and Regime-switching and asset allocation.

Tactical asset allocation: value and momentum

Nomura mentions ‘Value and Momentum Everywhere,’ a study authored by Clifford S. Asness, Tobias J. Moskowitz, and Lasse Heje Pedersen, and published in the Journal of Finance in June 2013, under the heading ‘Value and momentum.’

The study is notable for its examination of value and momentum across various asset classes jointly with a view to enhancing returns from a tactical asset allocation. The authors are of the view that “the greatest benefits in terms of increased diversification and investment returns are evident” from such a joint examination (for example, across equities, bonds, currencies and commodities) rather than studying each asset class in isolation.

Value and momentum everywhere

The authors of the study define the “value” effect as the relation between an asset’s return and the ratio of its book value relative to current market value. “Momentum,” on the other hand, is the relation between an asset’s return and its recent relative performance history.

“Most strikingly, we discover significant comovement in value and momentum strategies across diverse asset classes. Value strategies are positively correlated with other value strategies across otherwise unrelated markets, and momentum strategies are positively correlated with other momentum strategies globally. However, value and momentum are negatively correlated with each other within and across asset classes,” say the authors.

Figure: Cumulative returns to value and momentum strategies across markets and asset classes.

Plotted are the cumulative (sum of log) returns to value, momentum, and their 50/50 combination strategies in each of the eight asset markets considered: equities in the United States, the United Kingdom, Europe, and Japan; equity index futures; currencies; bonds; and commodities. Returns are plotted for the rank weighted factor portfolios, which are zero-investment portfolios that weight each asset in proportion to its rank based on either value or momentum. (Source: Value and Momentum Everywhere, Clifford S. Asness, Tobias J. Moskowitz, and Lasse H. Pedersen).

Liquidity risk

According to the authors, liquidity risk is a common thread running across the different asset classes, and is partly responsible for the negative correlation between value and momentum mentioned above.

“We find significant evidence that liquidity risk is negatively related to value and positively related to momentum globally across asset classes…and that value returns are significantly negatively related to liquidity risk globally, implying that part of the negative correlation between value and momentum is driven by opposite signed exposure to liquidity risk,” say the authors.

Nevertheless, according to the authors, liquidity risk provides only a partial explanation for their findings.

Shortcomings of existing behavioral theories

The authors candidly admit that the “strong correlation structure among value and momentum strategies across diverse asset classes is difficult to reconcile under existing behavioral theories,” and that their other findings such as the high return premiums and Sharpe ratio in a globally diversified value+momentum portfolio (“the efficacy of value and momentum across diverse asset classes”) are best left as challenges to be addressed by future research.