FYI: FEW WEEKS back, a reader—let’s call him Karl—challenged me with a question. Why, he asked, don’t I recommend momentum investment strategies?
If you aren’t familiar with the term, momentum strategies seek to buy stocks that have done well in the past, with the hope that they will continue rising, while also selling stocks that have done poorly, with the expectation that they will keep falling.
Karl asked why, in a recent article, I had dismissed momentum investing as the sort of thing that would turn your portfolio into an “unpredictable stew,” even though research has found that it can be profitable. It’s a fair question.
Regards,
Ted
https://humbledollar.com/2019/07/say-no-mo/
Comments
If you are disciplined, especially on setting your 'stop', MO can be fun and add a bit of profit. Many here do it.
Both skew and kurtosis are mentioned in the "Momentum Has Its Moments" paper, meaning that momentum investing has long, fat tails on the loss side (good chance of catastrophic losses). Nevertheless, in the long run, momentum works so well that even adjusted for risk, it performs better than the market.
Though as Keynes said, in the long run we are all dead. I have a pretty high risk tolerance, but the potential recovery time (decades) is too long for my taste, and I'm not fond of trying to catch a falling knife.
As to costs, the trading costs are real, and something to keep in mind. However, I have my doubts about the "extra work" involved (and posted a comment on the article page about that). Momentum investing can even entail less work, because it doesn't care about fundamentals. Fund analysts aren't going to be knocking on company doors, talking with CFOs, poring over business plans. They're more likely to be feeding P/Es, revenues, etc. into computers and seeing which companies rise to the top of the heap.
A simple example of how the game can be played might be John Hussman’s HSTRX - which Lipper describes this way: “The Fund seeks to provide long-term total return from income and capital appreciation by investing fixed-income securities, such as U.S. Treasury bonds, notes and bills, Treasury inflation-protected securities, U.S. Treasury Strips, and other U.S. Government agency securities.”
Yet, a quick scan of top holdings indicates approximately 15% to consist of precious metals mining companies. As might be expected, this “conservative income fund” jumped about 8% in the last quarter. (It suffered a loss nearly as large in the 4th quarter.) If gold keeps rising, the fund may well flaunt a 15-20% gain by year’s end. While representing only a small % of the fund, the driver in terms of over and under performance has always been its investments in metals and mining - not its bond managing capabilities.
Hussman doesn’t disguise this very well - so most here are aware of the reason the fund might over or underperform its peers during shorter periods. But if you carry the logic a little farther, it shouldn’t be hard to recognize that other fund managers can play the same game - even improve on it - by adding hot momentum funds to their holdings during rising markets, causing their funds to outperform, drawing in even more investment dollars, and allowing them to buy even more of the hot momentum stocks .....
You might say this is a classic case of the elephant chasing his own tail.
Oh, and Hussman is far from a momentum investor. He uses a bunch of stock value and economic data to predict the financial markets are doomed. Polar opposite of letting the trend be your friend.
https://what-when-how.com/finance/the-momentum-trading-strategy-finance/ The "Momentum Has Its Moments" paper I mentioned describes a strategy that sounds like this one on steroids - instead of selling past losers, one shorts them: No entry or exit plan; just pure momentum.
But allow me to attempt to explain. The fund manager who boosts returns by buying hot stocks (let’s assume “systematically”) is the real momentum player. He / she knows full well what they’re doing. The individual investor who moves money to that fund because it’s been “outperforming” its peers is the unwitting victim of the momentum strategy - thus, a “closet momentum player”. Hussman is a hard one to explain - more like a loose cannonball on the deck of a rolling ship during rough seas I’d say. (No telling where it will go or what damage may result.) However, if folks flock to HSTRX six months from now because they see a “bond fund” that’s been whipping other bond funds by 5 or 6%, they will have bought the momentum kool aid, and likely won’t realize it.
Just MHO. But you make good points. (Folks should be aware that both Mike and I invested with Hussman once upon a time and long ago)
Re: Doc Hussman - Yes. We’re both solidly in the “recovering” state now, having participated in the folly in our early years. So, it’s hard (for me anyway) not to look back and take an occasional jab at the humble fellow.
I've monitored, but not invested in MTUM; and the below chart starts with 2018, as this will let you view the moves during the short market whack in early Feb. as well as the big down on Dec. 24, 2018. I included DSEEX as a pseudo momentum active fund.
ARGH. Chart will only set back to July at this time.
SPY MTUM DSEEX Jan 2018 to date
Take care,
Catch
If you click on the left side of the time block below the graph and drag it to the left you can go back in time to Nov. 2013.
Yes, I forgot to mention that. You may drag the days bar from either end to shorten and also right click onto it for default ranges. Sometimes, like with this chart; I shorten the time period to 100 days or so, and then click and hold the day range slider and drag to left to see the 100 day periods going back. This allows for a nice tighter view.
1999 is the most rear view; perhaps otherwise if a subscriber, which I am not nor need more time.
M* does its own data analysis, and reports thusly on momentum: http://www.fwp.partners/wp-content/uploads/2016/09/Performance-Persistence-Morningstar-2016.pdf
Chasing these hot funds thus appears to be chasing funds that happen to have high momentum stocks, though not necessarily chasing momentum funds.
- I think you mean the funds themselves aren’t moving in a fashion consistent with having significant momentum over meaningful periods of time, but they tend to own stocks that have a degree of momentum. Sounds reasonable to me.
- If, on the other hand, you mean that the managers of these funds don’t intentionally buy stocks having lots of momentum, than I’d suggest: (1) intent is difficult to establish and (2) quite possibly the “herd mentality” has misled these managers into not recognizing that they’re buying stocks which are rising due more to momentum than to underlying fundamentals.
A four factor analysis is used to determine the style (strategy) of a fund. Carhart took Fama/French's three factor analysis and added momentum as a fourth factor. Funds that have a large momentum factor are deemed momentum funds. That's different from saying that a fund just happens to have a lot of high momentum stocks at the moment.
An absurd hypothetical may help to illustrate the latter. Consider a fund that invests in stocks beginning with 'A'. At a given moment, the 'A' stocks, like Amazon, Apple, Alphabet, etc. might have high momentum. A few months later, they might not. This fund is clearly not following a momentum strategy, because it's not trading in and out of stocks to maintain a high momentum factor. So it doesn't correlate well over time with momentum. Still, at the moment, it has the same type of portfolio as a momentum strategy fund.
From Carhart, p. 73 (pdf p. 18):
To me, momentum investing is discovering an established, stable trend in whatever category you are comfortable with, buying in incrementally as the trend plays out and having a very specific sell point if the trend breaks down. In my opinion, momentum investing is not buying a momentum-style fund. A fund cannot react quickly to change. To me, momentum-style funds just fall in the realm of buying "alternative funds", which personally I stay away from.