Combining value and momentum (HT Asness)

Cliff Asness of AQR recently published a paper entitled “Value and Momentum Everywhere”

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1363476

The main points for me were:

  1. Value and momentum are both broad and persistent anomalies.
  2. Value and momentum are reliably negatively correlated.

This second effect is rare across asset classes and may be very valuable for portfolio construction.  I will be exploring this further.

A very simple implementation is to take the “small value” (SV) data series from the French data library and add a momentum rule:

Invest when the previous month’s return is positive, otherwise go to cash (3% annual interest).

The result is to increase annual returns by several percentage points, reduce time in market to 67% and increase Sharpe by 50% to 1.2.

Note: the best return of 19.3% CAGR is without using the recession model, only the rule above.

Plotting with the results from the previous post:

blog figs

COMP-IBH Buy & hold Sharpe
SPX 11.2% 7.4%
Low beta 11.8% 11.4% 0.89
High beta 14.1% 6.6% 0.37
Small value 17.7% 15.8% 0.82
SV momo 17.5% 19.3% 1.21

blog figs

Examining the equity curve shows that SV momo is very robust in recessions.

Plotting the SV return for the current month against the next month shows the degree of autocorrelation present (see upward sloping trendline):

blog figs

ADDENDUM:

If desired, SV momo could be combined with other asset classes (e.g. gold, bonds, REITs) into a Faber-type tactical allocation :

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=962461

“Small value momo” returns very similar to the “top 3 of 13” asset strategy in that paper.

Another similar momentum switching strategy is COP which has the interesting property of real-time success in the last few years.  Switching allows capital to move to the best performing asset classes without attempting prediction, in accordance with the literature.

Momentum may also be combined with trend-following: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2126478

These addendum items require some more study.

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9 thoughts on “Combining value and momentum (HT Asness)

  1. Thanks so much for your very valuable value blog 😉 This is really great stuff. How can I understand the French database – what should I select, there are so many portfolios? -Thanks. Joe

    • Joe,
      Thanks for your support. I used the benchmark portfolios; there are 6 monthly series going back to 1926 (small / large * value / mid / growth). Values are monthly returns in basis points (0.01%).

      http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/f-f_portfolios.html
      The Fama/French benchmark portfolios are rebalanced quarterly using two independent sorts, on size (market equity, ME) and book-to-market (the ratio of book equity to market equity, BE/ME). The size breakpoint (which determines the buy range for the Small and Big portfolios) is the median NYSE market equity. The BE/ME breakpoints (which determine the buy range for the Growth, Neutral, and Value portfolios) are the 30th and 70th NYSE percentiles.

      • I do not see any stock ticker symbols for the benchmark portfolios? What am I missing?
        Thanks, Joe

      • Joe, the individual stocks are not listed. The process is as follows: every quarter, segment the market 6 ways (SV, LV etc.). Calculate average monthly returns across all stocks in each segment. Repeat every quarter.

        ETFs available today for the small value segment include VBR and IJS.

        VBR Top Ten Holdings

        1. BRE Properties, Inc.(BRE ): 0.47%
        2. American Capital Ltd(ACAS ): 0.47%
        3. RPM International Inc(RPM ): 0.47%
        4. Packaging Corporation of America(PKG ): 0.45%
        5. Carlisle Companies, Inc.(CSL ): 0.44%
        6. PerkinElmer Inc(PKI ): 0.44%
        7. Westar Energy, Inc.(WR ): 0.43%
        8. Kilroy Realty Corporation(KRC ): 0.42%
        9. Questar Corp(STR ): 0.42%
        10. National Retail Properties Inc(NNN ): 0.41%

        % Assets In Top 10: 4.41%
        Total Holdings: 1007

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