Momentum Investing

Are there ways to revive the fading performance of the short-term reversal (STR) strategy, which is long stocks with the lowest returns last month and short stocks with the highest? In their September 2023 paper entitled “Reversing the Trend of Short-Term Reversal”, David Blitz, Bart van der Grient and Iman Honarvar investigate revival of the strategy by suppressing its conflicts with either industry momentum or general momentum. Specifically, at the end of each month, they sort stocks into fifths (quintiles) in three ways:

1. Generic STR – sorting on simple last-month returns.
2. Industry-adjusted STR – sorting on last-month returns minus respective last-month industry returns.
3. Residual STR – sorting on 3-factor alphas (adjusting for market, size and book-to-market factors over rolling 36-month intervals), scaled for volatility over the past 36 months.

For each approach each month, they form a hedge portfolio that is long (short) the quintile with the lowest (highest) past performances. For all three approaches, they impose regional neutrality by sorting stocks separately within North America, Europe and the Pacific region. They also consider developed and emerging markets segmentation. Using end-of-month data for all stocks in the MSCI World index during December 1985 through December 2022 (an average of 1,745 stocks per year), they find that: Keep Reading

Does a simple relative momentum strategy applied to tradable U.S. Treasury term structure proxies produce attractive results by picking the best duration for exploiting the current interest rate trend? To investigate, we run short-term and long-term tests. The short-term test employs five exchange-traded funds (ETF) to represent the term structure:

SPDR Barclays 1-3 Month T-Bill (BIL)
iShares 1-3 Year Treasury Bond (SHY)
iShares Barclays 3-7 Year Treasury Bond (IEI)
iShares Barclays 7-10 Year Treasury Bond (IEF)
iShares Barclays 20+ Year Treasury Bond (TLT)

The second test employs three Vanguard mutual funds to represent the term structure:

Vanguard Short-Term Treasury Fund (VFISX)
Vanguard Intermediate-Term Treasury Fund (VFITX)
Vanguard Long-Term Treasury Fund (VUSTX)

For each test, we allocate all funds at the end of each month to the fund with the highest total return over a specified ranking (lookback) interval, ranging from one month to 12 months. To accommodate the longest lookback interval, portfolio formation commences 12 months after the start of the sample. We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance metrics. Using monthly dividend-adjusted closing prices for BIL since May 2007, for IEI since January 2007, for SHY, IEF and TLT since July 2002 and for VFISX, VFITX and VUSTX since October 1991, all through September 2023, we find that: Keep Reading

Do Relative Rotation Graphs (RRG), which visually segregate assets into leading, weakening, lagging or improving quadrants by relative performance, effectively identify equity sectors with relatively strong future returns? In his September 2023 paper entitled “Dynamic Sector Rotation”, John Rothe tests an RRG-based sector relative momentum strategy with stop-loss risk management based on volatility. Specifically, he:

• Selects a universe of 31 sector sector/subsector exchange-traded funds (ETFs) based on daily trading volume, years in existence, overlap with other sector/subsectors, assets under management and liquidity.
• Each week, holds the equal-weighted top 5 ETFs crossing into the RRG improving quadrant.
• Manages the risk of each holding continuously via a Wilder Volatility Stop with a 5-day range.
• Assumes a 2% annual management fee.

His benchmark is the S&P 500 Momentum Index. Using weekly returns for the selected ETF universe during a test period spanning January 2013 through mid-2023, he finds that: Keep Reading

Can network analysis discover useful momentum spillover across asset classes? In their August 2023 paper entitled “Network Momentum across Asset Classes”, Xingyue (Stacy) Pu, Stephen Roberts, Xiaowen Dong and Stefan Zohren employ a graph machine learning model to discover cross-class momentum connections and devise a network momentum strategy across 64 series of commodities, equities, bonds and currencies future contracts. They train the model on an expanding window of at least 10 years of history for eight momentum features, including volatility-scaled returns and normalized moving average crossover divergences (MACD) over different lookback intervals. They they then apply multiple linear regressions over different lookback intervals (seeking to avoid reversals) to devise a network momentum strategy for out-of-sample testing. Every five years, they retrain the graph model. Using daily prices of the 64 futures contract series during 1990 through 2022, such that out-of-sample testing commences in 2000, they find that:

Keep Reading

What is the right balance between seeking alpha and avoiding taxes? In their August 2023 paper entitled “Alpha Now, Taxes Later: Tax-Efficient Long-Only Factor Investing”, Yin Chen and Roni Israelov assess trade-offs between rebalancing benefits and tax avoidance from overlapping 10-year backtests of long-only momentum, value, quality and safety factor stock portfolios. They measure momentum as cumulative return from 12 months ago to one month ago, value as book-to-market ratio, quality as operating profitability and safety as winsorized market betas. All portfolios start with the equal-weighted top fifth (300 stocks) as ranked by the factor metric. After initial formation, they consider five monthly portfolio management rules:

1. Fully Rebalanced, each month selling stocks that drop out of the top fifth and buying stocks that enter the top fifth, but not adjusting weights of stocks that remain in the portfolio.
2. Buy-and-Hold (no rebalancing over the 10-year portfolio life).
3. Sell Losers at Losses, each month selling stocks that have migrated to the bottom fifth if they have capital losses.
4. Tax Loss Harvesting, each month selling stocks with more than 5% unrealized losses and not buying them back until at least 30 days later.
5. Tax Loss Harvesting and Sell Losers, selling stocks that have migrated to the bottom fifth even if they have unrealized capital gains so long as the aggregate realized capital gain is zero.

They form the first portfolio for each factor in June 1964 and initiate new portfolios every six months until January 2012, such that the last portfolio is held through December 2021. They focus on 1-factor (market) alpha, averaged across overlapping portfolios, as the key performance metric. To calculate net performance, they assume 0.08% 1-way trading frictions, 23.8% dividend tax rate and 23.8% (40.8%) long-term (short-term) capital gain tax rate. Based on initial findings, they repeat all tests on composite portfolios of value, quality and safety factors constructed by ranking stocks on individual factors and investing equally in the fifth of stocks with the highest combined rankings. Using data as specified for the 1,500 U.S. stocks with the largest market capitalizations at the end of each prior year during 1964 to 2021, they find that:

Keep Reading

Instead of searching among hundreds of firm/stock characteristics to identify those that best predict stock returns, what about first finding the stocks with the highest and lowest past returns and then examining the characteristics of those stocks? In his June 2023 paper entitled “Essence of the Cross Section”, Sina Seyfi identifies the strongest determinants of expected stock returns by:

1. Sorting stocks into fifths (quintiles) at the end of each month during the last 10 years based on monthly returns (120 sets of quintile portfolios).
2. Computing the average monthly value of each of 206 firm/stock characteristics among stocks in each quintile across the last 10 years.
3. Forming each month out-of-sample quintiles that are as similar as possible regarding these 206 average characteristics to the in-sample returns-sorted quintiles.
4. Studying variations of the 206 characteristics across these out-of-sample quintiles to identify the most important drivers of future stock returns.

This method allows for non-linearities and interactions among characteristics, which a conventional linear regression method does not. Using returns and characteristics data for publicly listed U.S. common stocks and the U.S. risk-free rate as available during 1926 through 2021, he finds that:

Keep Reading

What characteristics of U.S. equity factor return series are most relevant to respective factor performance? In his May 2023 paper entitled “The Cross-Section of Factor Returns” David Blitz explores long-term average returns and market alphas, 60-month market betas and factor performance cyclicality for U.S. equity factors. He also assesses potentials of three factor rotation strategies: low-beta, seasonal and return momentum. Using monthly returns for 153 published U.S. equity market factors, classified statistically into 13 groups, during July 1963 through December 2021, he finds that:

Keep Reading

Why is trend following so persistently popular among investors? In their March 2022 paper entitled “A Guide to Trend Following Strategies”, Stuart Broadfoot and Daniel Leveau describe popular trend identification methods and provide an example of how to build/test a multi-asset class trend following strategy in four steps. Using trend following index data during January 2000 through May 2022 and prices for 52 futures contract series during January 2000 through January 2022, they find that: Keep Reading

A subscriber asked about the performance of a variation of the monthly reformed 50-50  Simple Asset Class ETF Value Strategy (SACEVS) Best Value-Simple Asset Class ETF Momentum Strategy (SACEMS) Equal-Weighted (EW) Top 2 combination that substitutes 100% SACEMS EW Top 2 whenever both:

1. SPDR S&P 500 ETF Trust (SPY) is the selection for SACEVS Best Value at the end of the prior month.
2. SPY is below its 10-month simple moving average at the end of the prior month.

The objective of the variation is to suppress SACEVS Best Value drawdowns. To investigate, we compare performance results for this variation (“Filtered”) with those for baseline 50-50 SACEVS Best Value-SACEMS EW Top 2. Using monthly returns for SACEVS Best Value and SACEMS EW Top 2 since July 2006 (limited by SACEMS) and monthly dividend-adjusted prices for SPY since September 2005, all through March 2023, we find that: Keep Reading

Is timing of U.S. equity factors broadly and reliably attractive? In their March 2023 paper entitled “Timing the Factor Zoo”, Andreas Neuhierl, Otto Randl, Christoph Reschenhofer and Josef Zechner analyze effectiveness of 39 timing signals applied to 318 known factors. Factors include such categories as intangibles, investment, momentum, profitability, trading frictions and value/growth. Timing signals encompass momentum, volatility, valuation spread, characteristics spread, issuer-purchaser spread and reversal. Specifically, they:

• Forecast monthly returns for each factor and each signal (12,402 timed factors).
• Aggregate timing signals using partial least squares regression.
• Construct multi-factor portfolios that are each month long (short) the fifth, or quintile, of factors with the highest (lowest) predicted returns.
• Investigate composition of optimal factor timing portfolios, considering such properties such as turnover and style tilt.

Using monthly factor and signal data as available (different start dates) during 1926 through 2020, they find that: Keep Reading