The momentum factor

30 September 2022 _ News

The momentum factor
We shall continue with the analysis of investment factors. 
 
In the first instalment, we defined factor investing. In order to put into practice a concept that may not be so straightforward, we can offer the following analogy: factors are to allocation as macronutrients are to food. A balanced diet should include all major macronutrients, just as a well-balanced portfolio should diversify across different investment factors.
 
How do factors behave during various phases of the economic cycle?
 
Answering this question is important, and a portfolio manager, within an asset allocation process, must know how to prioritise exposure to the factors that are most responsive to the phase of the cycle in which they are operating, according to this chart.
 
 
 

 

We shall now analyse the MOMENTUM factor.

Stocks defined as "high momentum" are characterised by high performance recorded over a circumscribed and relatively short period of time (typically the last 6 to 12 months). The manager will focus their attention on these stocks, as empirical evidence and academic studies confirm that their outperformance relative to the market tends to continue in the subsequent short term.

The table demonstrates a clear example where MOMENTUM has almost always clearly outperformed the parent index, MSCI WORLD LOCAL.

 

 

As with all strategies, this process must be methodological and disciplined, that is, applied and monitored periodically so that the best-performing portfolio is obtained at all times. It is commonplace to point this out, but it is clear that the persistence of a trend is not perpetual; otherwise, we would just have shares that go up and others that go down.  Furthermore, it is always necessary to consider whether or not to continuously fine-tune, which could increase the cost of rebalancing the portfolio.

If we wanted to identify the most opportune time to apply this strategy within an economic environment, then the phase of overt expansion of the cycle undoubtedly turns out to be the best phase for implementation, as it is precisely in the second phase of the economic situation when recovery stocks have performed better and, for that reason, will be considered on trend, while value stocks will begin to record overpriced parameters.

During the last two-year COVID period, through momentum strategies, managers have identified certain sectoral and geographic trends that have achieved explosive performance, but here it is also worth mentioning the specificity of the context we were experiencing, namely of low or falling rates (through QE), through which growth stocks (TECH, HEALTH CARE, BIOTECH) played a leading role during the stay-at-home economy.

 

 

 

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