A momentum strategy may be implemented at an individual stock level or sector level.
Is there an advantage to partitioning stocks into sectors and owning the strongest sector versus buying the highest momentum stocks in the market? Stock momentum funds have been available for a few years and recently sector rotation has been packaged into an ETF.
Ken French publishes a 10 industry portfolio and momentum portfolios for US equities which may be used to investigate:
The blue curve is the top sector (ranked by 12 month return, monthly). The red curve is top tercile stocks (ranked by 12 month return, monthly) in the largest 50% by market cap.
Sector rotation clearly outperforms stock momentum (by about 3% annually since 1950). However, this result is for the highest ranked sector only. It is difficult to determine the fraction of the market represented by the top sector versus top tercile large stocks but the sector slices are likely smaller.
Multiple sectors are compared below. Top 2 and top 3 returns are comparable with the individual stock momentum strategy.
Compare the “Top 1” curve with the simple rotation between value and momentum shown on this blog. Similar performance (17% CAR) but with only 2 instruments and fewer trades.
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Finally, combine sectors with value, momentum and risk-free (RF). The top ranked portfolio by 12 month return is selected every month:
Returns are improved about 1% annually over the entire data-set but the 4% out-performance since 2000 (from avoiding the GFC correction) accounts for the majority.
Summary stats
Conclusions
A rotational strategy with the top sector outperforms the large momentum FF stock portfolio. However, this may be partially due to selecting a smaller section of the market.
These tests show that beating a simple value-momentum rotational model is tough. Adding ten sectors to this model increases returns slightly, but at the expense of higher turnover.
This demonstrates what is possible with price-based ranking only. Adding volatility and correlation to the scoring may give further improvement (e.g. Keller 2015 “Classical Asset Allocation”):
RRSP Strategy 
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Thanks for citing the paper I co-authored ^_^
It’s a good paper, more on that soon!
Thanks for your great blog! How do you rotate between momentum, value and risk-free? Do you follow your for year cycle and with a stop-loss? – Thanks!
Thanks, I rank on past 12 month returns and buy the highest ranked instrument, every month.
Thanks, that’s a very good idea. Simple and efficient. Can’t beat that.
While we are at it… would you prefer MTUM or PDP for the momentum ETF? MTUM has quite lower expense ratio. Thanks!
Lower expense ratio is good, and MTUM has been the better performer: https://ca.finance.yahoo.com/q/bc?s=MTUM&t=2y&l=on&z=l&q=l&c=pdp
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