Sector Alpha Momentum Strategy?
July 14, 2017 - Momentum Investing
Is recent Fama-French 5-factor alpha (accounting for market, size, book-to-market, profitability and investment risks) a useful predictor of U.S. equity sector performance? In other words, is there an alpha momentum anomaly at the sector level? In their June 2017 paper entitled “US Sector Rotation with Five-Factor Fama-French Alphas”, Golam Sarwar, Cesario Mateus and Natasa Todorovic examine 5-factor alphas of U.S. equity sectors and test both long-only and long-short sector rotation strategies based on 36-month alpha ranking. They conduct long-sample conceptual tests on 10 Fama-French U.S. sector (or industry) portfolios and short-sample tests on S&P Select Sector SPDR exchange-traded funds (ETF). Specifically, they each month measure rolling alpha for each sector based on the last 36 months of returns, and:
- Long-only strategy – Each month take equal positions in sectors with positive alphas at the end of the prior month.
- Long-short strategy – Each month take equal long (short) positions in sectors with positive (negative) alphas at the end of the prior month.
- Alternative long-only strategy – (1) each month during U.S. economic expansions (per NBER), take equal positions in sectors with positive alphas at the end of the prior month; and, (2) each month during U.S. economic contractions, hold 1-month U.S. Treasury bills (T-bills).
They also compare effectiveness of Fama-French 3-factor model versus 5-factor model for analysis of sector returns. Using monthly returns for Fama-French sectors and factor models, monthly returns for the S&P 500 Index and T-bill yields since January 1964, and monthly returns for sector ETFs since January 1999, all through December 2014, they find that: