Cliff Asness: Fama On Momentum Investing
The long-term success of the momentum factor seems to be a challenge to many observers. People say things like “momentum only works among small stocks” or “momentum only works for going short, not long.” These comments, which appear to be aimed at casting doubt on the implementability of momentum, seem to be spoken about more than written. There’s a reason for that. When you run the numbers, these statements are just not close to true. We’ve disproven a whole gaggle of them here. But, like many misperceptions, once in the zeitgeist they remain hard to kill.
Given this long history battling momentum myths, I have to admit I felt some trepidation when I could sense this interview with Professor Eugene Fama turning toward the momentum strategy. While my faith in Professor Fama is exceptionally high, this is one of the few topics where he can indeed give me the jitters. I wrote my dissertation for him, way too long ago now, focusing in large part on the success of the momentum strategy back when it was still big news (it is still big, just not news). Even though he was incredibly supportive of the research (and the researcher!) it is obviously a result that he’s never really liked. In fact in the video he says he’s still “hoping it goes away.” This makes sense because, as Fama discusses, it’s one of the harder factors to reconcile with the Efficient Markets Hypothesis (EMH), a contribution for which he is justifiably acclaimed. In fact, he calls momentum the “biggest embarrassment to the theory” out there. While I believe that Professor Fama and I agree on much more than we disagree (my own nuanced, perhaps cowardly, position on EMH is detailed here) and we would ultimately recommend very similar investments (at least when confined to the traditional world of long-only investments), I have differed with him on momentum before — most notably, I’m still somewhat befuddled how one stops at a five-factor model and doesn’t make momentum the sixth. So as this interview moved to the topic of momentum I braced myself as I knew it was one of the few areas where I might disagree with one of my heroes, in this case a hero with a Nobel prize! It turns out I did disagree. Kind of. Well, it’s complicated.
Not surprisingly, Professor Fama didn’t make any of the most common egregiously wrong, silly statements regarding momentum (you wouldn’t catch him saying, for instance, that momentum doesn’t work for large caps, when it indeed does — and better than for value, using his and Ken French's data). Still, he said a few things I think need a response (I say with fear as I type…).
Keeping in mind that the debate I’ve had with Professor Fama, sometimes from afar, on this topic has been ongoing for more than two decades, some of the discussion below is necessarily layered with that long history. Someone just listening to this interview may miss some of that context so I’ll try to provide it. Our respective written pieces on many of these topics cited above, and later on, also help paint the backdrop of issues.
It’s a difficult sequence to discuss as, like many conversations, the interview jumps between concepts and it’s sometimes hard to tell which concept they are referencing. I guess that’s to be expected when I choose to obsessively dissect a brief period of a live interview! So I hope you'll bear with me. It all starts around the 24½ minute mark (though I recommend listening to it all both for context for this discussion and because it’s, you know, Professor Fama).
First, he mentions momentum’s turnover in two very different ways. One, as simply indicating it’s more costly to trade (more on that later) than a lower-turnover strategy, and two, as he believes that the higher turnover of momentum makes it implausible that “risk” can explain its high average returns. In an efficient market, higher expected returns only come with higher risk and Professor Fama states that he finds it implausible that risk changes so much so quickly that it would drive the momentum premium. I get what he’s saying about risks not changing that rapidly, but my own intuition about risk comes more from how the returns on a strategy behave rather than from a strategy’s turnover. For example, if the returns to following momentum looked risky in an economic and/or intuitive sense, such as losing money in very bad times, it would matter to me much more than the strategy’s turnover — in this case, I could believe a story where momentum had a big enough effect on risk to overcome Professor Fama’s turnover worry. The flip side is also true, in that a low-turnover strategy that never produces any risky outcomes would certainly not seem risky and indeed not have a plausible risk explanation.
Professor Fama quite correctly points out that transactions costs, even for small stocks, have come in far lower in practical well-managed portfolios than many thought possible prior to this experience (say back in the early 1980s). However this same observation is true for momentum and often ignored. Momentum, while higher turnover, also has the additional advantage of being one of the more historically effective factors in large-cap stocks, which are cheaper to trade (the opposite to one of the myths surrounding it — that it only works for small stocks!). Professor Fama does graciously note that today’s even lower costs would, of course, make momentum even cheaper to implement going forward.
Then there’s a very short odd segue where he mentions that momentum has never worked in Japan. Here I just have to lower my estimation of my own reach or ability to convince people as I thought I’d settled this one! I had hoped he’d read this and agreed that momentum and value should be studied together as a system. Well, now I hope he hasn’t read it, because the alternative is that he read it and disagreed! Anyway, as the author I’m obviously incredibly biased but I can’t see how someone can read the paper "Momentum in Japan" and still off-handedly drop “Momentum hasn’t worked in Japan” and think it’s even a glancing blow to the overall momentum story. As I detail, if one evaluates momentum in tandem with the value factor or if one accounts for any reasonable amount of randomness then the results in Japan are either supportive of, or no real blow to, the evidence in favor of the momentum factor. Anyway, given that momentum works pretty much ... what’s the word I’m looking for? ... near everywhere, citing its worst showing among so many markets (where it still adds in the presence of the value factor) seems exceptionally weak tea. But, I have to say, that’s what Professor Fama appears to be doing here, sowing the seeds of doubt, if you will.
Then the really interesting, and frankly a little disappointing, part happened. The Professor got a question from the interviewer about a recent paper by Professor Toby Moskowitz (a colleague of both Fama’s at the University of Chicago and of mine at AQR)