- Wealth PMS (50L+)
Momentum Investing, in a nutshell, is a strategy that picks stocks that have had higher relative returns over the recent past and holds them for a defined period of time. Historical and live performance reviews have shown momentum investing outperforms buying and holding the market index.
How can such a simplistic strategy offer long-term outperformance versus the market?
This page brings together a curated set of research and resources on Momentum Investing. It does not mean to be exhaustive but to point to the most meaningful and cited papers on Momentum Investing. Taken together, the resources on this page should offer investors new to and already familiar with momentum investing a perspective on how and why momentum works. Links to the original papers are provided as references for those who’d like to dive into them.
One of the earliest mainstream academic studies on momentum investing was published in 1993, by Narasimhan Jegadeesh and Sheridan Titman, from Anderson Graduate School of Management, UCLA.
Abstract: This paper documents that strategies which buy stocks that have performed well in the past and sell stocks that have performed poorly in the past generate significant positive returns over 3- to 12-month holding periods. We find that the profitability of these strategies are not due to their systematic risk or to delayed stock price reactions to common factors. However, part of the abnormal returns generated in the first year after portfolio formation dissipates in the following two years. A similar pattern of returns around the earnings announcements of past winners and losers is also documented.
The researchers tested various portfolios built using a “J-month / K-month” strategy where stocks were picked based on returns of the past J months and held for K months after portfolio formation. Both J and K varied from 3 to 12 months, in three-month increments. The research tested every combination.
Their finding, all combinations of past returns and holding period, barring one outperformed a basic buy-and-hold strategy net of costs.
This 1999 paper by Tobias J. Moskowitz of the Chicago Graduate School of Business (now Chicago Booth), and Mark Grinblatt of Anderson School of Business, UCLA examined the industry component in a stock’s momentum on 32 years of data from 1963 to 1995.
Abstract: This paper documents a strong and prevalent momentum effect in industry component of stock returns which accounts for much of the individual stock momentum anomaly. Specifically, momentum investing strategies, that buy past winning stocks and sell past losing stocks, are significantly less profitable once we control for industry momentum. By contrast, industry momentum investment strategies, which buy stocks from past winning industries and sell stocks from past losing industries, appear highly profitable, even after controlling for size, book-to-market equity, individual stock momentum, the cross-sectional dispersion in mean returns, and potential microstructure influences.
The findings suggest that industry momentum explains a large part of individual stock momentum and that industry momentum persists even in the largest, most liquid stocks.
This paper by Prof. Greet Rouwenhourst, Robert B. and Candice J. Haas, Professor of Corporate Finance at Yale Som School of Management, studied the prevalence of momentum in emerging markets from 1980 to 1995.
Abstract: International equity markets exhibit medium-term return continuation. Between 1980 and 1995 an internationally diversified portfolio of past medium-term Winners outperforms a portfolio of medium-term Losers after correcting for risk by more than 1 percent per month. Return continuation is present in all twelve sample countries and lasts on average for about one year. Return continuation is negatively related to firm size, but is not limited to small firms. The international momentum returns are correlated with those of the United States which suggests that exposure to a common factor may drive the profitability of momentum strategies.
International Momentum Strategies; K Geert Rouwenhorst: https://doi.org/10.1111/0022-1082.95722
By Tobias Moskowitz, Yao Hua Ooi, and Lasse Hej Pedersen, the paper expanded the scope of examining momentum to over 25 years of data on five dozen diverse financial instruments, including country equity indices, currencies, commodities and sovereign bonds.
Abstract: We document significant “time series momentum” in equity index, currency, commodity, and bond futures for each of the 58 liquid instruments we consider. We find persistence in returns for 1 to 12 months that partially reverses over longer horizons, consistent with sentiment theories of initial under-reaction and delayed over-reaction. A diversified portfolio of time series momentum strategies across all asset classes delivers substantial abnormal returns with little exposure to standard asset pricing factors and performs best during extreme markets. Examining the trading activities of speculators and hedgers, we find that speculators profit from time series momentum at the expense of hedgers.
There is a distinction between time-series momentum and the regular definition of momentum, which is cross-sectional. Time-series momentum compares the recent return of security with its own historical return, while cross-sectional momentum compares securities with other securities over the same time period.
Time Series Momentum: Asness, Ooi, Pedersen: Paper
The analysis considers monthly returns for 67 markets across four major asset classes: 29 commodities, 11 equity indices, 15 bond markets, and twelve currency pairs. They constructed equal-weight combinations of 1-month, 3-month, 12-month time-series momentum strategies from Jan 1880 to Dec 2016, 136 years, rebalanced monthly. The results showed 11% annualised excess return over the period considered.
Even assuming a 2-and-20 fee model (2% of AUM as fixed fee and 20% of gains), a momentum-based strategy outperformed net of costs in every decade from 1880 to 2016, with a minimum outperformance of 2.6% from 1880 to 1889 and a maximum of 15.1% from 1970 to 1979.
A century of trend-following investing: Hurst, Ooi, Pedersen: Journal of Portfolio Management Paper
Published in the Journal of Portfolio Management, this paper was authored by Cliff Asness, Andrea Frazzini, Ronen Israel, and Tobias Moskowitz of AQR Capital.
On the first page, they make this telling assertion about the prevalence of momentum as a factor for outperformance, not only in stocks but across assets and countries:
“The existence of momentum is a well-established empirical fact. The return premium is evident in 212 years (yes, this is not a typo, two hundred and twelve years of data, from 1801 to 2012) of US equity data, dating back to the Victorian age in UK Equity data, in more than 20 years of out-of-sample evidence from its original discovery, in 40 other countries, and in more than a dozen other asset classes.”
Subsequently, they look at and debunk several myths about momentum investing, including whether its outperformance was limited to smallcap stocks or non-existent when considered net of costs. The outcome showed persistence in momentum’s outperformance over passive benchmarks in each case.
Fact, Fiction and Momentum Investing (aqr.com)
Eugene Fama is the Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business (formerly the Chicago Graduate School of Business). His biography page on the Chicago Booth website refers to him as the “father of modern finance”. A significant part of that honorific rests on his 1970 research on the efficiency of Capital Markets.
Efficient Capital Markets Hypothesis, in a nutshell, states that capital markets are efficient in processing information. So stock prices at any time are based on the correct evaluation of all available information at that time. i.e. In an efficient market, prices fully reflect available information. And if all information is correctly reflected in prices at any time, there is no way to profit from identifying mispricing.
For his research on Efficient Capital Markets, Prof Fama and his co-authors, Robert j Shiller and Lars Peter Hansen, were awarded the Nobel Prize for Economic Sciences in 2013.
This research went a long way in the emergence of passive investing and making EMH a core part of the finance curriculum in business schools worldwide.
In 2008, Prof Fama published a paper titled “Dissecting Anomalies“, which explored returns from specific investment strategies that did not conform to the Efficient Market Hypothesis. In this paper, he and his co-author Kenneth R French, based on an analysis of 42 years of data, from 1963 to 2005, concluded “anomalous returns associated with net stock issues, accruals, and momentum are pervasive.”
Over time, the other stock-picking strategies were challenged, sometimes successfully, Momentum as an aberration to the Efficient Markets Hypothesis, has endured, leading Prof. Fama to call it the “premier anomaly”.
Researchers have proposed several behavioural explanations for why a strategy that buys past winners and sells past losers outperforms the market so consistently over centuries of data across asset classes and countries.
Underreaction (or Anchoring Bias or the Frog-in-the-Pan hypothesis): Investors are inattentive to information arriving continuously in small amounts, so a series of frequent gradual changes attracts less attention than infrequent dramatic changes. This means a company with consistently but gradually improving performance would not attract significant attention offering the opportunity for a momentum strategy and to enter and ride the gradual price rise.
Zhi Da, Umit G. Gurun, Mitch Warachka, Frog in the Pan: Continuous Information and Momentum, The Review of Financial Studies, Volume 27, Issue 7, July 2014, Pages 2171–2218, https://doi.org/10.1093/rfs/hhu003
Disposition Effect: A natural inclination to sell winners but hold on to losers to avoid losses. This means consistent selling from existing investors acts as a brake on the stock price, making the price rise more gradual and therefore allowing a momentum strategy to enter
Mark Grinblatt, Bing Han, Prospect theory, Mental Accounting and Momentum, Journal of Financial Economics, Volume 78, 2005, http://www-2.rotman.utoronto.ca/facbios/file/momentum_JFE.pdf
Cognitive Dissonance: News that contradicts investor sentiments causes cognitive dissonance, which tends to get ignored or disbelieved, thus slowing its diffusion into stock prices. Thus losers keep getting underpriced while winners keep getting overpriced, sustaining their momentum.
Multiple global research papers have confirmed the persistence of momentum. We did our own study into Indian markets and how momentum has performed in India.
We examined a few variants of a momentum investing strategy, Naive momentum, along with volatility-adjusted versions. All momentum portfolios comfortably outperformed a Nifty Buy-and-Hold strategy. Adding volatility-adjusted Sharpe return ratios helped improve the risk-return profile of the strategy by reducing the impact of sharp market drawdowns on portfolio performance.
An adequately diversified portfolio of stocks offers protection against company-level risk. But how many stocks? Beyond what point do the benefits of diversification suffer from diminishing returns?
We tested different portfolio configurations and their performance and downside volatility to identify the sweet spot of maximizing return while containing downside risk.
We found somewhere between 20 and 30 stocks optimal. Adding more stocks took away from return potential while not adding much by downside protection.
We examined the performance of the NIFTY Factor Indices from their inception in 2005 to 2022. The study included single-factors: Low Volatility, Alpha, Beta, Quality, Value, and of course Momentum, and some multi-factor strategies like Alpha-Low Volatility, Alpha-Quality-Low Volatility so on.
Over a decade and a half of data show Momentum as a factor for outperformance over passive market benchmarks and other factors.