Dual Momentum Investing


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Mean variance optimization produces unstable results when the covariance matrix is ill conditioned and small input differences can lead to large output differences. CAPM models did not perform well in empirical testing as well. Risk parity gained popularity after the Global Financial Crisis but the higher allocation to bonds due to its low volatility, may not be the way forward given interest rates are near historic lows.

An innovation approach is to combine absolute and relative momentum. This adaptive asset allocation approach keeps investors in tune with changing market regimes and keeps investors out of trouble (better risk adjusted returns and lower max drawdowns).

Gary Antonacci explored combining absolute and relative momentum on a few asset classes. Specifically he anchors the portfolio with US stocks and switches into non US stocks using relative momentum. Absolute momentum is applied by comparing the stronger equity index with a risk free rate of return. When the chosen equity index outperforms the risk free rate of return, invest in the chosen equity index. If the chosen equity index underperforms the risk free rate of return, invest in a bond index.

Gary showed us in his book that while both absolute and relative momentum outperforms the relevant benchmark, a combination of absolute and relative momentum produces the best risk-adjusted returns with significant max drawdown reduction.

The strategy of combining absolute and relative momentum proved to be robust with different lookback periods as well as different ways of defining absolute momentum.

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