By David Berns, PhD, Nasdaq Dorsey Wright
Momentum has proven to be one of the strongest and most robust sources of returns since modern markets were established, having been empirically verified for over 200 years across all major asset classes (Geczy & Samonov, 2015). But as investors have ramped up their focus on systematically capturing a variety of alternative return sources (e.g. quality, low volatility, etc.), myths about momentum have proliferated.
In this article we will tackle the three most egregious misperceptions about momentum:
- Momentum is tax-inefficient due to its high turnover.
- Momentum is the same thing as growth since both focus on securities that have "done well"
- Momentum is an overtly risky trading strategy since it invests in the highest flying names.
The goal of this paper is to provide a rigorous review of where these myths come from and why they are inaccurate. By the end of this paper you will hopefully have a refined understanding of the realities of momentum investing:
- Momentum is actually rather tax-efficient given its propensity to rotate holdings at short-term losses and long-term gains.
- Momentum and growth portfolios actually have little overlap in holdings due to their dramatically different screening criteria.
- Momentum is actually one of the best risk mitigation tools available to long-term investors when utilized to avoid downturns.
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Some performance information presented is the result of back-tested performance. Back-tested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes to illustrate the effects of the strategy during a specific period. Back-tested performance results have certain limitations. Back-testing performance differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight. Performance results (both backtested and model performance) do not represent the impact of material economic and market factors might have on an investment advisor’s decision making process if the advisor were actually managing client money. Dorsey, Wright & Associates, LLC (collectively, with is parent company and affiliates “DWA”) believes the data used in the testing to be from credible, reliable sources, however; DWA makes no representation or warranties of any kind as to the accuracy of such data. Past performance is not indicative of future results. Potential for profit is accompanied by possibility of loss. Nasdaq® is a registered trademark of Nasdaq, Inc. The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM A SECURITIES 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.