Learning From AQR's "The Case for Momentum Investing"

Relative Momentum is a persistent anomaly and complements a value-focused portfolio.

In this article, Absolute Momentum will be used interchangeably with trend following or time series momentum. Relative Momentum will be used interchangeably with cross-sectional momentum or relative strength.

The paper shows that stocks with the best momentum outperform the ones with the worst momentum, both in absolute terms and relative to the equity market as a whole. See “Exhibit 1” of the paper, reproduced below.

The Case for Momentum Investing - AQR - exhibit1

Source: AQR Capital Management


The paper also shows that relative momentum exists in a range of global asset classes and markets in “Exhibit 2” of the paper, reproduced below.

The Case for Momentum Investing - AQR - exhibit2

Source: AQR Capital Management


Adding Relative Momentum to a Value-focused portfolio improves risk-adjusted returns as measured by the Sharpe ratio. See “Exhibit 6” of the paper (reproduced below).

The Case for Momentum Investing - AQR - exhibit6

Source: AQR Capital Management


Momentum will persist for a period of time (6-12 months) before ultimately leading to reversals as too many investors pile on and prices become detached from fundamentals. Consistent with this intuition, investments do not exhibit momentum over just any time horizon. For instance, we cannot say that the stocks that have performed best over the last five years will do so over the next five years. Indeed, on a five-year horizon we find the opposite effect in the data. Stocks that outperform for a long period of time will generally become expensive, and expensive stocks tend to under-perform less expensive stocks. This is the value effect, and long-run past performance is a good (backwards!) value indicator. However, the evidence does show that assets that have performed well over the last 12 months tend to do better over the next 3- 12 months than assets that have performed poorly over that same period. This is the time horizon in which momentum works best.

Research Paper: The Case for Momentum Investing

Authors: Adam L. Berger, CFA, Ronen Israel, Tobias J. Moskowitz, Ph.D.

Organisations: AQR Capital Management, University of Chicago

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