Trend Following And Momentum Strategies For Global REITs by SSRN
University of Reading – Henley Business School; City University London – Sir John Cass Business School
City University London – Sir John Cass Business School
Steve Thomas
City University London – Sir John Cass Business School
James Seaton
City University London – Sir John Cass Business School
June 8, 2015
Abstract:
This study investigates whether the risk adjusted returns of a global REIT portfolio would be enhanced by adopting a trend following strategy (which is an absolute concept), a momentum based strategy (which is a relative concept and requires individual country allocations), or indeed a combination of the two. We examine the results in terms of both a dedicated Global REIT exposure, and the impact on a multi-asset portfolio. We find that the main improvements arise when the broad index is replaced with one of the four trend following (TF) strategies. The portfolios deliver similar returns but volatility is reduced by up to a quarter to the 8-9% range, the Sharpe ratios increase by 0.1 to 0.5 with the main benefit being the reduction in the maximum drawdown to under 30% compared to 43% when the broad index was used. We thus find that a combined momentum and trend following Global REIT strategy can be beneficial for both a dedicated REIT portfolio and adding REITs to a multi-asset portfolio.
Trend Following And Momentum Strategies For Global REITs – Literature Review
The nature of the benefit of adding REITs to a multi asset portfolio has been widely researched (Lee and Stevenson 2005), with recent evidence (Lee 2010) confirming that both the benefit (be it return enhancement, diversification, or risk reduction) and the size of the impact are time-variant. Studies on the impact of adding listed real estate to a direct portfolio (Moss and Farrelly 2014) have shown that there is a positive return enhancement, and that the relative risk contribution of listed real estate is lower than expected. However the majority of studies have adopted a “buy and hold” strategy for adding listed real estate to a multi-asset portfolio. We add to these findings by asking rather different questions: firstly, in a multi asset global portfolio comprising equities, bonds, commodities and property, and employing simple rule-based asset allocation methods, what role would property play? Secondly, pursuing a momentum investment strategy across all 4 asset classes, is there a significant and time-varying role for the regional REITs indices? This strategy genuinely involves only past data and has no look back bias often associated with Mean Variance comparisons which form forecasts based on perfect foresight. Thirdly, we move on from using passive REITs strategies to construct investment strategies using a set of country REITs and apply trend following and momentum strategies to create portfolios with superior investment performance.
Following the market dislocation in the Global Financial Crisis of 2007-2009 the key risk variable (after liquidity) that a number of practitioners started to focus on was maximum drawdown, and how to minimise it without sacrificing returns. This class of risk measure actually has a long history of both practical and theoretical importance dating from Roy (1952). The prospect of losing several years (or even decades) of value accumulation in a brief period meant that attention turned to strategies which could minimise the full loss crystallised in a buy and hold strategy. The two most obvious strategies which could be applied to REITs are momentum and trend following.
The classic equity strategy highlighted by Jegadeesh and Titman (1993) involves buying the ‘winners’ over the past 6-12 months and selling the ‘losers’ over the same period.
This is frequently referred to as cross-sectional momentum, or relative momentum by Antonacci (2012). Studies by Erb and Harvey (2006) and Miffre and Rallis (2007) demonstrate the effectiveness of this approach within commodity markets.
An alternative type of momentum investing is where one is interested only in the direction of prices or returns rather than how they fare against their peer group. This type of activity is known as trend following (other names include time series momentum and absolute momentum) and is frequently used by Commodity Trading Advisors (CTAs) (see Szakmary et al, 2010). As examples, trend following rules may use the current price relative to a moving average (Faber, 2007), or the length of time that excess returns have been positive over a range of timeframes (Hurst et al, 2012). The aim is always to trade in the direction of the prevailing price, i.e. when prices are rising long positions are taken and when prices are falling then cash or short positions are taken.
Evidence for the effectiveness of trend following strategies has been presented by Faber (2007), ap Gwilym et al (2010) and Moskowitz et al (2011), amongst others. Clare et al
(2012) demonstrate that when relative momentum is compared to trend following it is the latter that provides by far the more impressive investment performance enhancement for a variety of asset classes. A few studies have considered combining relative momentum with other established equity strategies such as value. Asness (1997) observes that momentum is present in both value and growth stocks in the US but that the effect is larger in the latter. Similar results are observed by ap Gwilym et al (2009) in the UK when momentum is combined with dividend yield. Clare et al (2014) study a variety of international markets and find that trend following enhances the risk-adjusted returns of both value and growth companies, but particularly for the latter.
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