Swedroe: Momentum Distinctions

November 14, 2018

Today my colleague at Buckingham Strategic Wealth, institutional services advisor Tim Jost, will look at some of the latest research on the momentum factor. The following is his analysis.

To begin, momentum is a phenomenon discovered in returns where those assets that have performed well recently will continue to perform well. Momentum has been studied extensively since 1993, when the original paper “Momentum” was published by Narasimhan Jegadeesh and Sheridan Titman. Strong proponents of efficient market theory, Eugene Fama and Ken French have referred to the momentum premium as the “premier anomaly” among those studied in the financial literature.

Different Types Of Momentum

Two different variations of momentum have been identified and studied by researchers—cross-sectional momentum and time series momentum. While similar in nature, cross-sectional and time series momentum have been identified as distinct premiums or sources of return in the financial literature.

Cross-sectional (CS) momentum ranks assets by recent performance and takes a long position in those that have outperformed relative to other assets, and goes short those that have underperformed. Thus, cross-sectional momentum looks at recent performance of assets on a relative basis to other assets.

Time-series (TS) momentum takes a long or short position on an asset by only looking back at its own absolute performance during the ranking period. Thus, if an asset’s price has been going up (down), a TS momentum strategy will go long (short) that asset. Managed futures strategies have typically targeted the capture of the TS momentum factor.

An important distinction between how these two strategies/factors have been defined is that CS momentum is a zero-net investment strategy—it is long the same dollar amount of assets as it is short—while TS momentum can be either net long or short through time. Because returns tend to be positive, on average, over time, TS momentum strategies tend to take larger long positions than short positions, thus having a time-varying net long investment outlay.

Relevant Research

In their 2012 paper “Times Series Momentum,” authors Tobias Moskowitz, Yao Hua Ooi and Lasse Pedersen claim that while time series momentum is related to cross-sectional momentum, it is ultimately a separate premium. Thus, two distinct types of momentum exist, according to their assertions. Moskowitz, Ooi and Pedersen also claim that a TS momentum strategy is more profitable than a CS momentum strategy.

Additionally, the authors conclude that TS strategies fully explain and subsume CS strategies. Given this, they recommend that a factor based on TS momentum be included in multifactor asset pricing models and suggest that this factor can help explain existing asset pricing phenomena, including CS momentum premiums.

In their July 2017 paper “Cross-Sectional and Time-Series Tests of Return Predictability: What Is the Difference?” the authors, Amit Goyal and Narasimhan Jegadeesh, respond to Moskowitz, Ooi and Pedersen’s claims and contribute to the research by concluding that TS and CS momentum are not distinct sources of return, and that differences in returns stem from the time-varying net long exposure to risky assets of TS momentum.

The authors also conclude that CS momentum strategies actually outperform TS momentum strategies when both are scaled to have similar dollar investment outlays.

Differences In Returns Between TS, CS Momentum

Goyal and Jegadeesh first look at similarly scaled TS and CS momentum strategies using historical U.S. common stock data. Their data covers the period 1946 through 2013. They sort returns based on a range of prior returns and holding periods (from one to 60 months). Both TS and CS strategies are scaled to have total positions, both long and short, equal to two dollars, which allows for an apples-to-apples return comparison across the two strategies.

The authors find striking differences between the excess returns of TS and CS strategies, which are similar to Moskowitz, Ooi and Pedersen’s findings when looking across international asset classes. Below are the highlights of these differences:

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