Momentum based investing in a downturn

[Molar Mechanic]

Read through the recent WCI post on Factor Based Investing https://www.whitecoatinvestor.com/factor-investing-review-of-your-complete-guide-to-factor-based-investing/ and was interested in the momentum based investing.  I've tried many different thoughts on investing, but have been mostly index focused for a long time.  The Momentum Strategy/Factor is something I'd not heard of till his post, though I've obviously watched many stocks balloon over the last 18 years.

 

iShares has a Momentum ETF https://www.ishares.com/us/products/251614/ishares-msci-usa-momentum-factor-etf that has incredible one and three year returns, but no history beyond that.

 

What do you thing will happen to this thing in a downturn?  My guess is outsize losses to match the outsize gains.  Even Apple lost >50% in 2008/2009, though they seem to have done ok now.

[Zaphod]

Molar Mechanic wrote:

Read through the recent WCI post on Factor Based Investing https://www.whitecoatinvestor.com/factor-investing-review-of-your-complete-guide-to-factor-based-investing/ and was interested in the momentum based investing.  I’ve tried many different thoughts on investing, but have been mostly index focused for a long time.  The Momentum Strategy/Factor is something I’d not heard of till his post, though I’ve obviously watched many stocks balloon over the last 18 years.

 

iShares has a Momentum ETF https://www.ishares.com/us/products/251614/ishares-msci-usa-momentum-factor-etf that has incredible one and three year returns, but no history beyond that.

 

What do you thing will happen to this thing in a downturn?  My guess is outsize losses to match the outsize gains.  Even Apple lost >50% in 2008/2009, though they seem to have done ok now.

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Momentum, which really really depends on how defined and implemented (look back periods, what assets to choose from, buy/sell periods, triggers, vol sensitivity) can be widely different. Typically they are described as slightly lag to similar during bull markets and out performing in downturns. That particular one looks to hold individual securities, some do indexes, etfs, etc...Usually during the regime change between markets they get a bit of whiplash.

I've seen backtests look great but fail in real time, hard to say. These returns are large, is it the strategy, beta, risk, etc...

Economic Philosopher has an excellent few pieces on momentum. As does the dual momentum guy.

[The White Coat Investor]

Momentum is known to crash pretty hard. More choices than ever before though. USAA has a combined small value and momentum fund and Vanguard is coming out with a momentum ETF soon. I'll be looking at that pretty closely. But even if I add a momentum ETF (which we haven't decided), it's not going to be more than 5% of portfolio and I'm not sure whether I'd pull it from the 15% in small value or the 25% in TSM.

[ajm184]

Was reading an article in the WSJ last weekend in Wealth Advisor section called; Is your Stockpicker Lucky or Good.  Article was about a philosophical 'reformation' of a former LTCM founder Victor Haghan.  For the unaware, LTCM in the late 90's basically had an a lot of nobel winning economists who traded using extreme leverage and came fairly close to bringing down the financial system.  Anyway, he started an asset management firm (Elm Partners) using ETF's/low cost mutual funds using three factors; market beta, value, and momentum.  The website has a paper discussing the approach with the math so everyone can judge the merits for themselves.

Seems a lot like the DFA philosophy without the cost (charge 12 bps/year) for the separately managed account.  The issue is the 300k minimum and the continued long term discipline to capture the factors which they estimate at 250 bps long term.  One reason I'm not sold on DFA is the use of a lot of different funds and reliance upon your advisor to 'rebalance'.

[Hatton]

Yes I remember LTCM blow up. I also saw that wsj article.  It was a big deal when it happened.  Interesting about face.

[NJDoc]

Personally I like momentum , and employ it in my portfolio, albeit with professional management. I tried doing it alone and I just don't have the discipline, so I let the pros handle it. I view it as a sort of insurance against large market drops , as that is when it actually shows it's best value. As mentioned by Zaphod it will lag behind bull market turns, it won't get you in at the bottom or out at the top but it will protect your account from a 2008 event. Like all techniques it has it's weaknesses. Also it is best used in a tax deferred account. Having lived through 2000 and 2008 I think it is a valuable risk management tool, albeit one of many.

If you are interested read Gary Antonacci's book on Dual Momentum. Also Todd Tressider , the Financial Mentor offers a very detailed course on investing and his take on buy and hold vs momentum.

 

[Zaphod]

NJDoc wrote:

Personally I like momentum , and employ it in my portfolio, albeit with professional management. I tried doing it alone and I just don’t have the discipline, so I let the pros handle it. I view it as a sort of insurance against large market drops , as that is when it actually shows it’s best value. As mentioned by Zaphod it will lag behind bull market turns, it won’t get you in at the bottom or out at the top but it will protect your account from a 2008 event. Like all techniques it has it’s weaknesses. Also it is best used in a tax deferred account. Having lived through 2000 and 2008 I think it is a valuable risk management tool, albeit one of many.

If you are interested read Gary Antonacci’s book on Dual Momentum. Also Todd Tressider , the Financial Mentor offers a very detailed course on investing and his take on buy and hold vs momentum.

 

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I like the way EP utilized it in his models. Basically didnt 'turn it on" until large economic indicators changed (ue rate, real retail sales. (smoothed ma's)), otherwise just held the market. That way you let it loose when it does its best and otherwise hold the market. Obviously that has its pitfalls as well, but seemed very reasonable otherwise when all things considered.

[PhysicianOnFIRE]

Miles Dividend MD tried the Dual Momentum strategy for a year and wrote about it. His results weren't great.

[The White Coat Investor]

I think it's important to distinguish that there are a lot of different things that all call themselves momentum investing. To be precise, you'll need to be more specific.

[Molar Mechanic]

Well, I went ahead and moved ~3% of my portfolio into a US Momentum ETF that tracks the MCSI index, though at a slightly lower expense than the one listed above.  We shall see what happens, but I doubt it makes much of a difference in the long run.

[Zaphod]

The White Coat Investor wrote:

I think it’s important to distinguish that there are a lot of different things that all call themselves momentum investing. To be precise, you’ll need to be more specific.

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I absolutely agree. So many permutations you really do have to be careful lumping them all in together. Aside from the myriad of factors that can be manipulated in your buy/sell, lookback, vol, etc..etc...you have many different ways to implement what is basically a risk on vs. risk off phase of your strategy. Some do individual stocks and others use etfs. Infinitely variable.

Also important to realize how incredibly easy it is to overfit a strategy and not realize its a random association or worked during that time, but not going forward. Its very easy to do. Matter of fact I could probably whip up 10 different strategies that absolutely crushed the market the last 20 years, and I could nearly guarantee they will not do so going forward. At least I wouldnt have any faith in it.

The other factor is you have to be able to stick with it, which sounds easy if it does well during downturns, but that means giving up some upside during the good times which isnt so easy. Make it more sensitive (shorter look back and hold periods) and you get whipsawed more often, make it less sensitive (increase those) and your changing assets at exactly the wrong time missing moves entirely.

[Dont_know_mind]

This is something I have been mulling over recently also.

Momentum should do worse than the index at major turning points - e.g you will be overweight tech in 2000, resources and housing in 2008 and Bitcoin/Tesla or whatever is momentum whenever the next bear market SHTF.

Momentum may also get blown out of the water at the end of bear markets (e.g being short financials in March 2009)

Trend followers like to distinguish themselves from momentum, but I am not sure if they can. My incomplete (dumb) understanding is that trend following may well do worse than the index at turning points but much better during trending markets (up or down). They do worse than index or momentum during non-trending markets apparently. The actual performance depends critically on the actual fund and how they manage themselves and risk within their particular stated strategy.

I don't have much faith in factor tilting. I am not convinced about the basis for the factors.

Rather than having say 5% in trend following, long/short ETF's, you could just have a 5% cash allocation.

I probably believe in having some cash, say 5-10% when things are starting to get significantly overvalued.

I have 110% risk asset/property exposure currently (10% leverage), but intend to dial this down to 95% risk assets, 5% cash (no leverage) by next February.

I was thinking of putting the proceeds of a property sale into something but will probably keep it in cash and have 5% portfolio cash buffer. It is not good to have too much cash though because it is a drain on performance.

I don't really buy the bond argument because bonds look like even worse value than equities or property currently, to me anyway - they are basically at a 200 year low, and possibly near a 2000 year low, or lowest ever recorded history low or some such ? Theoretically they should act as a hedge to equity volatility but I could imagine that they don't. Maybe the 30 year will go to closer to zero during the next bear market, but I wouldn't want to bet on that. I want to make sure I have some cash in the next bear market and would rather have 5% cash than bonds that should theoretically go up, but in actuality may or may not do this. But that is a pretty eccentric, non-mainstream, and probably erroneous view on my part. As the cash loading is not going to be high, it won't hurt me too much if I am wrong.

Basically, I would like to have some cash when there is wholesale liquidation.I am a believer that taking the other side of wholesale liquidation can be profitable.

I am not convinced that bonds are as safe as they are made out to be and prefer to have that 5% in cash - well not actual cash but short term liquid and safe instruments. The other option would be to put the 5% in long/short ETF's but that seems like a bit of a risk to me, probably because I have never invested in a long/short or trend following ETF's or hedge funds. I am not interested in momentum at this stage in the cycle but I could be wrong.

The other part of my plan, and I am not sure if this is dumb or not, was to accumulate 10% cash if things get very overvalued, bubble like.

The other part of me thinks I should just stay in 110% risk assets until things do get clearly bubble-like but it's probably not worth the stress and what if the bottom falls out before then ?

I would not go beyond 10% cash though, because I've been so wrong on so many occasions in the past about how far things could go up in terms of overvaluation. The right balance is a personal and elusive thing when the future is so unpredictable.

Michael Covel's interview with Swedroe I thought was interesting:

https://www.trendfollowing.com/2014/09/29/ep-278-larry-swedroe-interview-with-michael-covel-on-trend-following-radio/

 

[Zaphod]

Dont_know_mind wrote:

This is something I have been mulling over recently also.

Momentum should do worse than the index at major turning points – e.g you will be overweight tech in 2000, resources and housing in 2008 and Bitcoin/Tesla or whatever is momentum whenever the next bear market SHTF.

Momentum may also get blown out of the water at the end of bear markets (e.g being short financials in March 2009)

Trend followers like to distinguish themselves from momentum, but I am not sure if they can. My incomplete (dumb) understanding is that trend following may well do worse than the index at turning points but much better during trending markets (up or down). They do worse than index or momentum during non-trending markets apparently. The actual performance depends critically on the actual fund and how they manage themselves and risk within their particular stated strategy.

I don’t have much faith in factor tilting. I am not convinced about the basis for the factors.

Rather than having say 5% in trend following, long/short ETF’s, you could just have a 5% cash allocation.

I probably believe in having some cash, say 5-10% when things are starting to get significantly overvalued.

I have 110% risk asset/property exposure currently (10% leverage), but intend to dial this down to 95% risk assets, 5% cash (no leverage) by next February.

I was thinking of putting the proceeds of a property sale into something but will probably keep it in cash and have 5% portfolio cash buffer. It is not good to have too much cash though because it is a drain on performance.

I don’t really buy the bond argument because bonds look like even worse value than equities or property currently, to me anyway – they are basically at a 200 year low, and possibly near a 2000 year low, or lowest ever recorded history low or some such ? Theoretically they should act as a hedge to equity volatility but I could imagine that they don’t. Maybe the 30 year will go to closer to zero during the next bear market, but I wouldn’t want to bet on that. I want to make sure I have some cash in the next bear market and would rather have 5% cash than bonds that should theoretically go up, but in actuality may or may not do this. But that is a pretty eccentric, non-mainstream, and probably erroneous view on my part. As the cash loading is not going to be high, it won’t hurt me too much if I am wrong.

Basically, I would like to have some cash when there is wholesale liquidation.I am a believer that taking the other side of wholesale liquidation can be profitable.

I am not convinced that bonds are as safe as they are made out to be and prefer to have that 5% in cash – well not actual cash but short term liquid and safe instruments. The other option would be to put the 5% in long/short ETF’s but that seems like a bit of a risk to me, probably because I have never invested in a long/short or trend following ETF’s or hedge funds. I am not interested in momentum at this stage in the cycle but I could be wrong.

The other part of my plan, and I am not sure if this is dumb or not, was to accumulate 10% cash if things get very overvalued, bubble like.

The other part of me thinks I should just stay in 110% risk assets until things do get clearly bubble-like but it’s probably not worth the stress and what if the bottom falls out before then ?

I would not go beyond 10% cash though, because I’ve been so wrong on so many occasions in the past about how far things could go up in terms of overvaluation. The right balance is a personal and elusive thing when the future is so unpredictable.

Michael Covel’s interview with Swedroe I thought was interesting:

https://www.trendfollowing.com/2014/09/29/ep-278-larry-swedroe-interview-with-michael-covel-on-trend-following-radio/

 

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I think trend following is probably just momentum without putting any kind of fancy mechanism to it, and there are zillions of ways to do that as well. Yes, they will both suffer whiplash and dramatic losses at the turn, but they (obviously this is in theory) should cut those losses rather quickly and keep it from getting much worse. It will again miss the turn, but have you all in much earlier than usual. As a result you're in for 90% of the good and out for 90% of the bad.

The real pain comes with not having your system set up correctly and suffering a bunch of false signals, or they just appear within a good system anyway, and you get a bunch of whiplash diminishing returns.

Factors overall can only accept so much cash before whatever was driving their performance is arbitraged away for the most part. Momentum is the most resistant to that of the factors. Most of them are far overplayed and they are marketing products so will get much more hype than deserved from the offering company.

Here is an excellent summary of trend following, signals, and finally an overall implementation. The last one is sufficient and excellent alone. They are long and sometimes in the woods.

http://www.philosophicaleconomics.com/2016/01/movingaverage/

http://www.philosophicaleconomics.com/2016/01/gtt/

http://www.philosophicaleconomics.com/2016/02/uetrend/

[jz]

I've used MTUM ( er = 0.15%) for 2.5 years and have learned it works well for me psychologically.  I endured the Nov.8 2016 tuning point with ease because I have strong faith in  human behaviors based upon greed and fear of missing out.  Momentum investing draws in the masses like a pherome and addictive drug. Anecdotally, MTUM appreciated slightly during the two year trendless interim Oct. 2014 to Oct.  2016.  I've compared MTUM to MMTM,PDP, DWTR, QMOM, and DWAQ.  I'll stick with MTUM; the others are higher ER, have ESG criteria, or are fund of funds.