Which Strategy Wins the Performance Game – Value or Momentum?
Today we’re looking at the concept of bar belling momentum and value strategies. I’ve been reviewing some of what I would consider to be important white papers that were written on various topics regarding how to invest in stocks and having a good strategy.
By Louis B Llanes, CFA CMT
Founder, Wealthnet Investments, LLC
Having a strategy that is based on long-term expectation and executing it well and timely is paramount. Even if it’s just a good one – it doesn’t even have to be an amazing one. If you have a good one and you’re consistently executing it, that is much better than just shooting by the hip, going by your gut, or going by intuition entirely. It takes a lot of mental fortitude to have a strategy and using it, and that’s something a lot of investors could benefit from.
Asness, Clifford S., “The Interaction of Value and Momentum Strategies,” Financial Analysts Journal, vol. 53, no. 2, 1997, pp 29-36.
There was a white paper that was written by Clifford Asness back in 1997 in the Financial Analysts Journal. He was a managing director at Goldman Sachs at the time, and with AQR.
What this is essentially saying is that strong momentum stocks are negatively correlated to strong value stocks. However, even though they’re not closely related, they are both related to outperforming the stock market in general. This means that they have some diversification benefits and they both have shown in the past to do better than “buy and hold.”
From reading that excerpt, you can form a simple chart. One side is momentum, high or low, and then the other side is be value – low or high valuation metrics.
Looking at this, we have polar opposites. In other words, if you have a group of stocks that are exhibiting a very high book market value to market value, the stocks that are beaten down, they do better than the stocks that are the momentum, which is the opposite. But if you just look at just the momentum stocks and forget about the value part of it, the stocks that are expensive based on book market to value, those tend to outperform.
I have colleagues who are hard-core value investors and they always disagree with the momentum. And vice versa – the momentum guys disagree with the value strategy. The stocks that are hitting highs and that are relatively performing well, they do great in reality. Both conditions are true, but they are opposite.
If you add momentum as part of your variables – a multifactor model that says give me those stocks that have good value and add momentum – that’s not as powerful as just saying, let’s just look at the value stocks. Let’s look at the value of these stocks and buy a basket of them, then look at the momentum of these stocks and get a basket of those – they’re inversely related and let’s blend them together.
I call this a kind of value/momentum barbell strategy. I first came up with this idea back in 1994 when I started learning about technical analysis early in my career, before I even graduated from college. As I got my CFA, I was introduced to value, and I noticed this phenomenon, not quantitatively, but just observing the markets. We had good results if we just bought those companies that had what I would call “stocks that are on a roll”, that had something good going on. In today’s world, think Amazon. It’s clearly not a value stock, however it doubles and it doubles even though it’s expensive.
If you blended those types of stocks with companies that were a strong financially, but they were beaten down, sometimes you can have a great performance record by blending those two.
I noticed this through observing and in studying some of the greats, like George Soros. He mentioned in his book that he would like to buy one of each. He would buy some of the stocks that were the best winners in the industry, then he would go down the list of the worst performers and try to find out if he could add to the portfolio.
I wanted to talk a little bit about that because I think that there’s a lot of confusion. People can tend to get too dogmatic about one or the other and try to stick to one camp. And the evidence for both is very strong. In fact, the momentum evidence is actually stronger than value, based on what I’ve seen. This is mainly because the spreads tend to be wider between high and low momentum and it tends to be more agnostic to certain biases. You have to pull out a lot of biases with fundamental data to get them to work and it’s a little bit more difficult. However, they both have been shown to have value.
The momentum/value barbell makes a lot of sense to me. I highly recommend it to those of you who are quantitatively oriented. The paper mentioned in this has been around for a long time, but I wanted to bring it up again because the market is down over one percent. As you read this, everybody’s worried about interest rates moving higher. There’s always going to be worry, and as we know, they say “the markets climb a wall of worry.” That’s very true. It is also true, however, that markets fall rapidly and steeply. It’s important to have good processes. It’s important to have a good strategy that you execute in a timely way. And that means you’ll never get rid of the emotion but having a strategy that is based on sound empirical evidence is a good starting point.
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