Antonacci, Dual Momentum Investing

In 2012 Gary Antonacci won the Wagner Award for his paper “Risk Premia Harvesting Through Dual Momentum”; the year before he was the runner-up with “Optimal Momentum Investing.” Now, with Dual Momentum Investing (McGraw-Hill) he has given the investing world a first-rate book-length analysis of the two kinds of momentum and how to combine them to beat the market.

For those who think momentum investing is “so 90’s,” Wesley Gray, coauthor of Quantitative Value, sets them straight. In his laudatory preface to the book he quotes Eugene Fama, who, despite the apparent challenge to his efficient market hypothesis, admitted that “momentum is pervasive.” But why is it pervasive, and how can investors capture the momentum anomaly?

Antonacci focuses on the second question but does address the first in a short chapter “Rational and Not-So-Rational Explanations of Momentum.” Let me start there. The rational explanation for why momentum works is that “high momentum profits are compensation for assuming greater amounts of risk.” The “not-so-rational” explanation is that “investors behave unexpectedly and irrationally in systematic and predictable ways.” (p. 36) In a nutshell, “herding/anchoring/ confirmation bias and the disposition effect complement each other and can lead to a unified, behaviorally based concept of momentum-inducing behavior.” (p. 43) If behavioral finance is more or less correct, “momentum lets us profit from human behavioral biases instead of being subject to them in adverse ways.” (p. 44)

All well and good, the reader might say. But we are all familiar with the adage that the trend is your friend--until it ends. How can the investor profit from momentum instead of being swept away by it?

Antonacci has thoroughly researched this question. Most important, he distinguishes between relative and absolute momentum. Relative strength “compares an asset to its peers in order to predict future performance. In academic research, relative momentum is often the same as cross-sectional momentum, which involves sectioning a universe of individual assets into equal segments and comparing the performance of the strongest segments (‘winners’) to the performance of the weakest (‘losers’).” By contrast, when viewed on an absolute or longitudinal basis, “an asset’s own past predicts its future.” (p. 84) Absolute momentum is “a bet on the continuing serial correlation of returns, or, in cowboy terms, absolute momentum says, ‘A horse is easiest to ride in the direction it’s already going.’” (p. 85)

The major weakness of relative momentum investing is that “relative strength does little to reduce downside exposure. Relative momentum may even increase downside volatility.” (p. 84) Absolute momentum, by contrast, not only provides greater downside portfolio protection than relative momentum; it even provides more downside protection than low volatility portfolios do “while preserving more upside market potential. It can also do this without the tracking error, sector concentration, and high turnover issues associated with low volatility portfolios.” (p. 88)

Antonacci’s recommendation is a deceptively simple one: “use absolute and relative together in order to gain the advantages of both. The way we do that is by first using relative momentum to select the best-performing asset over the preceding 12 months. We then apply absolute momentum as a trend-following filter by seeing if the excess return of our selected asset has been positive or negative over the preceding year. If it has been positive, that means its trend is up and we proceed to use that asset. If our asset’s excess return over the past year has been negative, then its trend is down and we invest instead in short- to intermediate-term fixed-income instruments until the trend turns positive.” (p. 89)

This is a dynamic approach to asset allocation, using only stocks and bonds for reasons that the author explains. The model (Global Equity Momentum--GEM) switches between the S&P 500 and the ACWI ex-U.S. based on relative strength momentum and uses aggregate bonds as a safe haven during bear markets based on absolute momentum signals taken from the S&P 500.

Between 1974 and 2013 GEM had an annual return of 17.43%, which soundly trumped relative momentum (14.41%), absolute momentum (12.66%), ACWI (8.85%) and ACWI + AGG (8.59%). Its annual Sharpe ratio was 0.87, in contrast to 0.52, 0.57, 0.22, and 0.28. And its maximum drawdown was 22.72%, as opposed to 53.06%, 23.76%, 60.21%, and 45.74%. “GEM benefited from absolute momentum in 1982, 2001, and 2009, when relative momentum offered no advantage over the market. On the other hand, GEM benefited most from relative momentum in 1986 through 1988 and 2004 through 2007 when stocks were strong and absolute momentum provided no advantage over the market.” (p. 105)

Although GEM is a simple long-term model, it is powerful. Antonacci’s extensive research and his clear-headed thinking have led to a book that every investor should read. The academically oriented reader will be grateful for his occasional excursions into the weeds, his carefully laid-out data, and his lengthy bibliography. The practically oriented investor will find a road map for moving ahead and staying out of really big trouble. And those who enjoy an infusion of humor will laugh at his mini-essay “All Aboard!” that wraps up the main text of book. This one’s a keeper!