Tuesday, October 20, 2009

Asness on Momentum

In a recent paper “Value and Momentum Everywhere” available for download from the Social Science Research Network Clifford Asness, Tobias Moskowitz, and Lasse Pedersen argue that value and momentum are negatively correlated both within and across asset classes and therefore make perfect portfolio partners. Asness, co-founder of AQR Capital Management which launched three three momentum mutual funds in July, has been beating the drum for momentum for some time. He argues that momentum has far outperformed growth over the last 80 years, although 2009 wasn’t kind to the strategy.

In an address at the Schwab Impact Conference in mid-September summarized in the Advisor Perspectives newsletter, Asness offered some hypotheses about why momentum works. First, investors are slow to adjust to news because of anchoring, so the price of a stock moves only part of the way on good news. Second, investors may overreact to good news, sending the price of a stock higher than is warranted. Third, investors are likely to sell their winners too early so there will be inventory available for those who want to ride the wave longer.

The momentum strategy does not itself exhibit the characteristics of momentum. It wins about two out of three years, and its odds of winning in a following year are independent of how it performed the previous year. The AQR momentum strategy, by the way, is based on the standard twelve-month time frame with a one-month lag (since stocks tend to mean revert in the short term). This time frame is critical, as the following graph indicates. (Click on images to enlarge.)

How has this strategy performed? According to AQR research:

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