It has been stated by no less than Eugene Fama, the 2014 co-recipient of the Nobel Prize in Economics that “The premier anomaly is momentum.”1 This idea that past winners tend to be future winners, while past losers tend to be future losers, has been vetted and established through hundreds of academic white papers on the topic.
Yet, momentum (aka relative strength) continues to be a misunderstood approach to investing. Why is momentum a strong investment factor that gives investors the potential to outperform over time? How exactly can momentum be exploited?
I think Tom Dorsey, Founder, Dorsey Wright & Associates, now a Nasdaq Company, explained the concept of momentum best:
If I gave you a list of the 100 best golfers worldwide and asked you to pick who you thought would be in the top 10 at the end of the next quarter, who would you pick? My guess is you would pick the current top ten to be in the top three months from now. Even if I asked you to pick the ones who would be in the top ten after one year, you would probably pick the current top ten.
At the end of the contest some would have fallen out and some would have moved up, but the majority would still be in the top ten. This is outperformance. It relates to Newton’s Law of motion, which suggests that objects that are in motion tend to stay in motion until an external force acts upon them. We believe that stocks that have good fundamentals, in a market that in general is supporting higher prices, and the chart pattern clearly shows that demand is in control of the stock, tend to continue to do well. Golfers who have good fundamentals, are in good shape, and at the top of their game, tend to continue to do well.
Buy the winners.
To the Data
For a simple illustration of the power of momentum, consider the following excerpt from a study published by Alex Bryan, CFA in this Morningstar article :
Momentum is pervasive. Many studies have extended this evidence to foreign stocks, commodities, currencies, and bonds. Momentum even works across individual asset classes and country stock indexes.
The tables below illustrate the momentum effect among large-cap U.S. and global stocks. Each column represents a fifth of the total number of stocks in the sample, which are ranked by their momentum. While there is not a linear relationship between the momentum quintiles, stocks with the highest momentum consistently outperform those in the lowest momentum quintile.
Source: Kenneth French Data Library
The returns above are based on the performance of indexes that are not available for direct investment. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.
We believe that investors who seek to employ an active investment strategy that strives to generate performance above that of a passive index over time should give strong consideration to making momentum a key component of their portfolios.
Accessing Momentum through Managed Accounts
Hopefully, at this point you are starting to wonder how you can put this powerful investment factor to work for your clients. We have a suggestion: Take a look at our family of Systematic Relative Strength Portfolios, which are available on a large and growing number of separately managed account (SMA) and unified managed account (UMA) platforms .
First, a little history. Since 1987, Dorsey Wright & Associates has been an advisor to financial professionals on Wall Street and investment managers worldwide, providing technical research and investment solutions. In 2002, John Lewis joined the portfolio management team at Dorsey Wright and was instrumental in leading an extensive period of research that led to the introduction of our family of Systematic Relative Strength portfolios. These portfolios have two major objectives:
- Systematize the investment management process to remove as much of the element of human emotion as possible.
- Focus the investment strategy around the most powerful return factor we could identify: momentum (aka relative strength).
This family of accounts now consists of eight different strategies:
Five of the eight strategies now have 10+ year track records.
Where Are These Strategies Available?
These portfolios are available on over 20 different platforms, including on many major wirehouses, regionals, discount brokerages, and Turnkey Asset Management Programs (TAMPs).
How to Receive More Information
For more information, contact us below and a member of our team will get back to you.
Dorsey, Wright & Associates, a Nasdaq Company, is a registered investment advisory firm. Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products. This document does not purport to be complete description of the investment strategies to which reference is made. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon. Each investor should carefully consider the investment objectives, risks, and expenses of the strategies discussed above prior to investing. Advice from a financial professional is strongly advised.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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