How efficiently can a sophisticated fund manager implement long-only stock momentum portfolios? In their December 2017 paper entitled “Implementing Momentum: What Have We Learned?”, Adrienne Ross, Tobias Moskowitz, Ronen Israel and Laura Serban use seven years of live data for long-only U.S. and international momentum funds to measure the import of implementation frictions. They segment these frictions into turnover/trading costs, tax impacts and mitigating portfolio construction choices. The underlying momentum strategies converge on the top third of stocks based on a combination of market capitalization and momentum signal strength (using multiple measures of momentum), reformed monthly. Portfolio construction employs a transaction cost model to minimize costs by: substituting stocks with similar momentum that are cheaper to trade, trading patiently and employing algorithmic trading rules designed to suppress price impacts of trades. Using detailed trade and performance data for the specified momentum funds during July 9, 2009 through December 31, 2016, they find that:
- On average across all momentum funds, actual transaction costs per dollar traded are 0.13%.
- Momentum fund one-way annual turnovers are on average roughly 80%-90%, ranging from 70% in 2013 to 151% in 2010.
- Average effective tax rate for original (more recent tax-managed) momentum funds is roughly 11% (5%). Tax-managed funds defer capital gains to convert short-term to long-term and accelerate short-term losses to offset realized gains, producing roughly one third lower turnover than original funds.
- Other portfolio construction techniques accrue an average annual benefit of about 0.30%.
- Over the sample period, relative to matched theoretical momentum indexes:
- The U.S. Large Cap momentum fund outperforms by an annualized 0.9%, with expenses/trading costs imposing -0.56% drag.
- The U.S. Small Cap underperformed by -1.2%, with expenses/trading costs imposing -0.92% drag.
- The International momentum fund underperformed by -1.1%, with expenses/trading costs imposing -0.83% drag.
In summary, evidence from recent live data suggests that long-only stock momentum strategies does not necessarily produce unworkable turnover, unbearable trading costs or significant tax burdens.
Cautions regarding findings include:
- The sample period is short. The authors state in mitigation that: “While seven years of live experience is still too short to evaluate the efficacy of a style portfolio such as momentum (i.e., what is the true gross momentum premium?), it is sufficient to learn something about its implementability in practice.”
- Trading frictions are likely much higher than those reported for small investors pursuing stock momentum strategies.
- As noted by the authors, momentum funds do not perform well relative to the market during the available sample period.
