A Century Of Data
Faber’s results are consistent with those of AQR Capital Management’s Brian Hurst, Yao Hua Ooi and Lasse Pedersen in their June 2017 study on time-series momentum, “A Century of Evidence on Trend-Following Investing.”
The authors constructed an equal-weighted combination of one-month, three-month and 12-month time-series momentum strategies for 67 markets across four major asset classes (29 commodities, 11 equity indexes, 15 bond markets and 12 currency pairs) from January 1880 to December 2016. The position these one-, three- and 12-month strategies take in each market is determined by assessing the past return in that market over the relevant look-back horizon.
A positive past excess return is considered an “up” trend and leads to a long position; a negative past excess return is considered a “down” trend and leads to a short position. In addition, each position is sized to target the same amount of volatility, both to provide diversification and to limit portfolio risk from any one market. Positions across the three strategies are aggregated each month, and scaled such that the combined portfolio has an annualized ex-ante volatility target of 10%.
Volatility scaling ensures the combined strategy targets a consistent amount of risk over time, regardless of the number of markets traded at each point in time. The authors’ results include implementation costs based on estimates of trading costs in the four asset classes. They further assumed management fees of 2% of asset value and 20% of profits, a traditional fee for hedge funds.
Following is a summary of their findings:
- Performance was remarkably consistent over an extended time horizon, one that included the Great Depression, multiple recessions and expansions, multiple wars, stagflation, the global financial crisis of 2008, and periods of rising and falling interest rates.
- Annualized gross returns were 18.0% over the full period, with net returns (after fees) of 11.0%, higher than the return for equities, but with approximately half the volatility (an annual standard deviation of 9.7%).
- Net returns were positive in every decade, with the lowest net return, at 4.1%, coming in the period beginning in 1919.
- There was virtually no correlation to either stocks or bonds. Thus, the strategy provides a strong diversification benefit. After considering all costs and the 2/20 hedge fund fee, the Sharpe ratio was 0.76. Thus, even if future returns are not as strong, the diversification benefits could justify an allocation to the strategy.
Hurst, Ooi and Pedersen write that “a large body of research has shown that price trends exist in part due to long-standing behavioral biases exhibited by investors, such as anchoring and herding [and I would add to that list the disposition effect and confirmation bias], as well as the trading activity of non-profit-seeking participants, such as central banks and corporate hedging programs.”
They observe, for instance, that “when central banks intervene to reduce currency and interest-rate volatility, they slow down the rate at which information is incorporated into prices, thus creating trends.”