Swedroe: Is ‘Momentum’ Faltering? Part II

August 01, 2014

Just because ‘momentum’ fades for a while doesn’t mean you should abandon it.

This is the second article in a two-part series about the momentum factor and whether or not its premium has permanently disappeared. The first article in this series appeared here.

Earlier this week, we took a look at some of the historical evidence on the persistence of the Fama-French momentum factor. Today we’ll examine the momentum premium’s out-of-sample record, as well as its uses in portfolio diversification.

The authors of the 2013 study, “212 Years of Price Momentum,” concluded that the most recent decade-long underperformance of momentum is not unusual, and that the momentum premium shifts with “regime” changes. The study examined the long-term evidence on momentum, merging three known 19th- and early 20th-century data sources into one testable data set from 1800 to 1927.

Out-Of-Sample Testing

After extending the data back to 1801, the study’s authors found seven other decade-long periods of negative returns, outside of the period from 2004-2013. The authors also found that the out-of-sample record of momentum has been exceptional.

After its published discovery, the positive premium has continued in the U.S. market, in the international markets, in currencies, and in commodities. They also cited the study “Value and Momentum Everywhere,” which traces the power of the momentum anomaly across the globe. And finally, they noted that the momentum factor has also been confirmed in 19th-century British stock prices.

Diversification Benefit

One of the more common mistakes investors make is to view the risk and return of assets in isolation. The right way to view assets is to determine how their addition impacts the risk and return of the entire portfolio.

For investors who tilt their portfolios to value strategies—which creates a larger-than-market exposure to the value factor—even if the momentum premium is low or negative, the research demonstrates that exposure to the momentum factor is still valuable for diversification purposes.



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