A Value or Momentum portfolio is selected each month, based on the highest previous 12 month return (R). Data are from Ken French’s library from 1950 to 2015. I use the large momentum portfolio and small value portfolio (the HML anomaly does not exist in large cap stocks).
I found two surprises:
1) Ranking on squared returns (n=2) consistently outperforms ranking by return alone (n=1). In other words, the magnitude of return is important, positive or negative. Mean reversion probably accounts for the improvement but this needs more detailed investigation. Annual returns exceed 20% over the last 4 decades.
The table shows that the n=2 strategy performs much better than the component portfolios, particularly this century: 17% compared to 13% and 8% for Value (V) and Momentum (M) respectively.
2) Overlaying an absolute momentum filter (hold cash when return < 0) degrades returns. The margin widens with recency: to 3.6% annually since 1999! Sharpe ratio is not materially reduced as deviation shrinks proportionally.