March 12, 2012

Value and Momentum...Not Here

Asness' firm, AQR Research, created the first fully disclosed momentum funds available to the general public (AMOMX, ASMOX, AIMOX). Asness also has a sense of humor, saying he has recurring nightmares about being hacked to death by a pack of rabid black swans. More money managers should have such nightmares.

In 2009, Asness and his colleagues released a working paper called "Value and Momentum Everywhere". The paper did a nice job showing that momentum works well with many different asset classes - foreign and U.S. stocks, country bonds and indices, commodities and currencies. Asness et al also tried to show how value would have performed with these same assets. Identifying value with equities is pretty straight forward; book-to-market is commonly used. However, trying to find comparable value metrics for other assets is not so easily done. Nevertheless, Asness et al reach the conclusion that value and momentum do well when mixed together 50/50, since the correlations between them are very weak. But they reach this conclusion using long/short portfolios of both momentum and value stocks. Very few actually invest this way. Long-only value and momentum portfolios are highly correlated.

The problem with that conclusion stems from the Asness momentum results. They are not as good as the ones we get from momentum using asset classes rather than individual equities and a combination of relative and absolute momentum.

Since determining non-equity value can be problematic, let's look at just equities to see what I mean. Below are the returns from January 1975 through December 2011 for the MSCI U.S. Value and MSCI EAFE Value indices, as well as a dual momentum strategy that is long either U.S. Treasury bills, the MSCI U.S. index, or the MSCI EAFE index based on 12 month momentum. Positions are rebalanced monthly. Transaction costs for momentum switches are negligible, with just 1.4 switches per year.


Dual Momentum
U.S. Value
EAFE Value
Annual Return
14.3
13.1
14.1
Annual Std Dev
12.4
15.1
17.7
Sharpe Ratio
0.66
0.47
0.45
Max Drawdown
-26.0
-54.6
-58.6


You can see that dual momentum approach outperforms the value indices. Let's now combine momentum with value as per Asness by weighting momentum 50% and each of the value indices 25%. Which results would you choose?


Dual Momentum
Momentum w/ Value 50/50
Annual Return
14.3
13.6
Annual Std Dev
12.4
12.3
Sharpe Ratio
.66
.61
Max Drawdown
-26.0
-37.8


The superiority of momentum over value is greater when you construct multi-asset dual momentum portfolios instead of using a portfolio that is limited to individual equities. Should there be value and momentum everywhere? I don't think so - not here anyway.

Results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Please see our Disclaimer page for more information.