Riding on Momentum
Blog post
December 15, 2015
Momentum, the tendency of past winners to continue to do well in the near future, is used widely in risk models and in quantitative strategies. Recently, momentum has also been the basis for factor indexes aiming to replicate the performance of this pervasive factor.
Several academic studies have reported impressive historical performance associated with the momentum effect. Momentum is generally defined in these studies as a strategy that simply goes long past winners and short past losers. These studies find that the momentum effect is present across most sectors, regions, markets, asset classes and time periods.
Momentum, the tendency of past winners to continue to do well in the near future, is used widely in risk models and in quantitative strategies. Recently, momentum has also been the basis for factor indexes aiming to replicate the performance of this pervasive factor.
As a result of the unique nature of this factor, the academic definition of momentum is extremely difficult to implement in practice because it tends to lead to high volatility exposure and excessive portfolio turnover. Volatility exposure makes the portfolio vulnerable to sharp drawdowns in periods of market turmoil, while high turnover would impose unnecessary transaction costs and a drag on performance.
In our paper, "Riding on Momentum: Understanding Factor Investing," we investigate alternative methods to address these challenges. Our solution involves selecting securities based on risk-adjusted performance and increasing rebalancing frequency only in periods of heightened market volatility. Selecting stocks based on risk-adjusted performance and rebalancing more frequently in turbulent times has historically mitigated momentum crashes and reduced unnecessary turnover in momentum strategies.
Simulated Momentum Strategies – Holding Period Analysis
Read the paper, "Riding on Momentum: Understanding Factor Investing."
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