We have had a chance to interview Gary Antonacci, a well known researcher in momentum based investing. Gary has done extensive research in the area of momentum based investing by extending it from relative strength based method (relative momentum) to absolute momentum. His work is very much related to MyPlanIQ’s Tactical Asset Allocation that essentially incorporates both types of momentum in asset allocation.
In the following, Gary gives many insightful comments on how the momentum based investing works and how it can be used in practice:
“A body in motion tends to stay in motion.” –
MyPlanIQ: Tell us about yourself.
Gary: I began my investment career in the 1970’s as a stockbroker, went on to get my MBA degree at the Harvard Business School, and was a private money manager for more than 30 years, specializing in underexploited investment anomalies. For the past 5 years, I have focused on research, writing, and consulting with respect to momentum investing. Although momentum investing has been around for many years, it is still very much underexploited and underutilized.
MyPlanIQ: Tell us the work you did that won you the NAAIM Wagner Awards for Advancements in Active Investment Management in both 2011 and 2012?
Gary: NAAIM is the National Association of Active Investment Managers. Every year they give the Wagner Award for the best research papers pertaining to advancements in active investment management. I received the second place award in 2011 and the first place award in 2012.
My 2011 paper, “Optimal Momentum: A Global Cross Asset Approach,” looked at momentum across combinations of different assets. Most research looks at momentum with respect to a single asset, usually individual stocks. My paper showed the advantages of using momentum to create balanced, multi-asset portfolios. My 2012 paper, “Risk Premia Harvesting Through Dual Momentum,” distinguished relative strength price momentum from absolute momentum and demonstrated the advantages of using both together.
MyPlanIQ: Tell us more about absolute and relative momentum and how to apply dual momentum to an asset allocation portfolio.
Gary: Relative momentum looks at price strength with respect to other assets. It is like being on a train, then hopping on to a faster one that comes along. Absolute momentum looks at an asset’s own positive excess return over a given time period. If the train you are on starts going backwards and there are no other trains moving in the right direction, you step off on to the platform.
Hundreds of research papers over the past 20 years have shown that momentum works best when you base it on past performance over the past 3 to 12 months. So, for example, if investment A is up 10% over the past year, while investment B is down 10%, then investment A has positive relative strength momentum with respect to investment B. It also has positive absolute momentum, but investment B does not, since it was down for the year. Both types of momentum can enhance return, but relative momentum usually does not reduce volatility or drawdown. Absolute momentum, on the other hand, because of its trend following nature, can reduce potential downside exposure through its market-timing feature.
The way to apply dual momentum is first to filter your investment opportunities to those assets showing positive absolute momentum over your chosen look back period. This means their trends have been positive. You then construct a portfolio of the strongest remaining assets, per relative strength momentum. Those who are interested can read more about this approach on my website, http://optimalmomentum/momentum.html.
MyPlanIQ: MyPlanIQ has had some coverage on risk parity portfolios. But they took a beating recently. What is your take on risk parity, momentum portfolios? Can they side step the problems faced by the standard risk parity approach?
A: Risk parity programs took a beating because they are heavily weighted toward bonds, which had trouble the second quarter of this year. Loses were magnified by the leverage used by many risk parity programs.
Dual momentum, risk parity portfolios sidestep these problems because you do not need to weight them as heavily toward bonds as non-momentum based risk parity portfolios. Momentum based portfolios also do not need leverage to meet their targeted return expectations.
Dual momentum equalizes and manages risk by staying in tune with market conditions. This means you need less risk reduction through large allocations to fixed income investments. You can read more about momentum and risk parity portfolios in my latest research paper, “Absolute Momentum: A Simple Rule Based Strategy and Universal Trend Following Overlay.”
MyPlanIQ: What benefits do you think an average investor can have with a momentum based approach in their (retirement and long-term) investments?
Gary: Momentum is one of the most heavily researched topics in modern finance. A recent paper, in fact, verified the value of momentum investing all the way back to 1801! Relative strength momentum has shown an ability to enhance risk- adjusted returns across nearly all asset classes and further back in time than any other factor. Absolute momentum can improve on this by reducing downside exposure in bear market environments. Intelligent momentum investing should lead to superior long- term risk-adjusted performance.
MyPlanIQ: What are the biggest roadblocks to this approach in practice?
Gary: The biggest roadblock is getting investors knowledgeable about the benefits and advantages of dual momentum investing. After much research, it took many years for investors to accept a value approach to investing. Research now shows that relative momentum gives twice the risk-adjusted returns as value investing, but few investors are willing to use momentum as a core investment approach. Absolute momentum, offering advantages over relative strength momentum, is less well known and even less popular right now. This should slowly change, as momentum research from the past 20 years becomes more widely known and more people start seeing superior real time momentum results.
Another roadblock to this approach in practice is the tendency for investors to become impatient with their investments and to make bad decisions based on short-term performance. This is not unique to momentum investing. The latest Dalbar figures show that stock mutual fund investors had an average annual return of 4.25% over the 20 years ending in 2012, while the S&P 500 had average annual gains of 8.21%. Investors, in general, tend to jump in and out of stocks at the wrong time. Relative strength momentum can be more volatile than non-momentum investing, which can exacerbate the tendencies for investors to enter and exit at the wrong time. Thankfully, absolute momentum often reduces downside exposure, which can help investors stay the course. This is another reason why dual momentum is the best approach.
MyPlanIQ: Any comment on momentum based investing in the current environment?
Gary: Some investors are concerned now about the reward-to-risk characteristics of the bond market, given the low level of interest rates. Others are cautious of equities, which may be expensive now based on higher than average valuations.
Dual momentum investing, however, is suitable for any market environment due to its adaptable nature. Absolute momentum will let you participate in whatever markets have positive trends. Relative strength momentum will keep you in the strongest instruments for as long as those trends persist. When the trends dissipate, dual momentum has the ability to take you to the sidelines before there is excessive damage to your portfolio. Given the uncertainties that face us right now, I would say that dual momentum investing is an ideal approach for most investors.
Thanks for a great interview. Interested readers can find more info on Gary’s website: Optimal Momentum.