Swedroe: A Close Look At Value & Momentum

July 07, 2014

Combining factors like value and momentum with gross profitability improves portfolio efficiency.

Two of the most studied capital market phenomena are the value effect, where value stocks outperform growth stocks; and the momentum effect, where recent relative performance predicts near-term returns.

Clifford Asness, Tobias Moskowitz and Lasse Pedersen add to the body of literature on this topic with their paper, “Value and Momentum Everywhere.” The study, which appeared last year in The Journal of Finance, examined the value and momentum effects across eight different markets and asset classes—individual stocks in the U.S., the U.K., continental Europe and Japan, as well as country equity index futures, government bonds, currencies and commodity futures.

The following is a summary of their findings:

  • There are significant return premiums for both value and momentum in every asset class. The value premium was persistent in every stock market, but demonstrated its strongest performance in Japan. The momentum premium was also positive in every market, especially in Europe, although statistically insignificant in Japan.
  • Value strategies are positively correlated with other value strategies across otherwise-unrelated markets, and momentum strategies are positively correlated with other momentum strategies globally. This persistence assuages data mining concerns.
  • Value and momentum are negatively correlated with each other within and across asset classes. The negative correlation between value and momentum within each asset class is consistent and averages -0.49. For stocks, the correlation averaged -0.60. The negative correlation between value and momentum and high positive expected returns imply that a simple combination of the two is much closer to the efficient frontier than either strategy alone. Combining strategies results in improved Sharpe ratios.
  • There’s significant evidence that liquidity risk is negatively related to value and positively related to momentum globally across asset classes. The implication is that part of the negative correlation between value and momentum is driven by opposite-signed exposure to liquidity risk. However, liquidity risk can only explain a small fraction of value and momentum return premiums and co-movement.

The paper’s authors offered this explanation for why momentum loads positively on liquidity risk and value loads negatively:



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