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FACTOR INVESTING
Key points
- Fact #1: Not all trends are equal. Jump to fact 1 >
- Fact #2: Momentum shouldn’t mean excessive turnover or costs. Jump to fact 2 >
- Fact #3: Opportunistic rebalancing matters. Jump to fact 3 >
- How to allocate to the momentum factor. Jump to section >
*World’s leading ETF provider: Based on over 800 ETPs and more than $1.2 trillion in AUM globally, BlackRock Global ETP Landscape as at 30 September 2017. Trusted to manage more money than any other investment firm: Based on $5.97 trillion in AUM globally, BlackRock as of 30 September 2017.
Momentum investing is about buying into trends and is based on the concept that winning stocks continue to win and losers tend to continue to lose. Over the long run, high momentum securities have tended to drive better returns than the market.1 In fact, we have seen momentum’s long-term outperformance in equities, bonds, commodities, foreign exchange, and even private markets like real estate. This makes momentum an investment factor – a broad, historically rewarded driver of returns within and across asset classes. It should be noted that momentum’s future performance is not guaranteed.2
1Source: MSCI as at 30th September 2017.
2Source: BlackRock as at 30th September 2017.
Like all investment factors, sub-optimal implementation of momentum strategies can result in poor performance or unintended investment outcomes. Momentum strategies can be vulnerable to painful volatility and naïve implementation may erode alpha over time. Here, we discuss three key pillars of a momentum strategy to help investors reap the strategy’s potential, while helping to avoid common pitfalls.
The MSCI World Momentum Index has outperformed the broad equity market benchmark, the MSCI World Index, over the past five years.
| Ann. return % Cum Return |
MSCI World Index | MSCI World MSCI World Momentum Index | Excess Return |
|---|---|---|---|
| 5 Year Annualised | 11.62% | 14.84% | 3.22% |
The figures shown relate to past performance. Past Performance is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy.
Source: MSCI, data as at 31 October 2017. It is not possible to invest directly in an index. Index performance is shown gross of fees. If fees were applied, performance would be lower. The MSCI World Momentum Index was launched on Dec 11, 2013. Data prior to the launch date is back-tested data (i.e. calculations of how the index might have performed over that time period had the index existed). There are frequently material differences between back-tested performance and actual results.
Fact #1: Not all trends are equal
Like most trends, price trends don’t last forever. We believe evaluating stocks based on both a six- and 12-month time horizon can help more consistently capture securities that are continuing to trend, while avoiding securities which are experiencing a reversion in performance. We also prefer to evaluate price trends on a risk-adjusted basis: measuring how much risk is involved in generating a security’s return in excess of the overall market. This allows the strategy to assess stocks on an even playing field and may prevent a strategy from loading up on highly volatile names.
Fact #2: Momentum shouldn’t mean excessive turnover or costs
Although momentum investing is trend-following by nature, an excessively short-term view can lead to high levels of turnover, boosting transaction costs and potentially eroding alpha over time. To reduce turnover, a momentum strategy could consider long-term signals, such as six- and 12-month metrics. Determining the rebalancing frequency also requires a give and take between maximising exposure to current trends, while trying to avoid overreacting to short-term noise.
Fact #3: Opportunistic rebalancing matters
Indeed, the momentum premium is in part a reward for bearing the risk of sharp, short-term reversals (market inflection points). As a result, changes in market sentiment can lead to sudden and occasionally deep draw-downs. The inclusion of a six-month momentum measure may help the momentum strategy recover more quickly, by reacting to the market’s new trend. Furthermore, having the flexibility to implement an opportunistic, off-cycle rebalance might be appropriate in instances of market volatility. This allows the momentum strategy to adjust to the new market environment to help avoid a potentially painful reversal.
| What is it? | Following upward price trends in a systematic way |
|---|---|
| How do we measure it? | 6 month price momentum 12 month price momentum |
| Index rebalancing | Semi-annually in May and November. Conditional rebalancing may be triggered by changes in monthly market volatility |
| Why it has worked | (x) Rewarded risk ( ) Structural impediment (x) Behavioural bias |
Implementing a momentum strategy
Momentum strategies can be used tactically or as strategic allocations, depending on the individual investment objective of the investor. We expect momentum strategies to perform well when the economy is in expansion mode and risk-seeking sentiment is strong.3 As a result, a tactical allocation to momentum may be an effective way to take advantage of a strengthening economy.
3Source: BlackRock as at 30th April
Momentum strategies can also play a role in the core of a portfolio, as a strategic allocation. In addition to potentially offering similar exposures, a momentum strategy could provide an attractive alternative to an underperforming growth fund, providing a similar factor exposure at a lower-cost.4 Momentum has had a historically low correlation with the 'value' factor and the implementation of a momentum strategy may help diversify a value-oriented portfolio.5
4BlackRock paper, Madhavan, Sobczyk, Ang (2016) “Estimating Time-Varying Factor Exposures with Cross-Sectional Characteristics with Application to Active Mutual Funds”
5Source: MSCI Research. Focus: Momentum.
Consider allocating to the momentum factor using iShares Edge Smart Beta ETFs
Key Risks
Investment risk is concentrated in specific sectors, countries, currencies or companies. This means the Fund is more sensitive to any localised economic, market, political or regulatory events.
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Share Class to financial loss.
Emerging markets are generally more sensitive to economic and political conditions than developed markets. Other factors include greater 'Liquidity Risk', restrictions on investment or transfer of assets and failed/delayed delivery of securities or payments to the Fund.
The value of equities and equity-related securities can be affected by daily stock market movements. Other influential factors include political, economic news, company earnings and significant corporate events.
Factor Focus Risk: Indices with a factor focus are less diversified than their parent index because they have predominant exposure to a single factor rather than the multiple factor exposure of most indices. Therefore they will be more exposed to factor related market movements. Investors should consider this fund as part of a broader investment strategy.
Indices with a factor focus are less diversified than their parent index meaning they are more sensitive to factor related market movements. Investors should consider this fund as part of a broader investment strategy
Index Methodology Risk: Although the Benchmark Index was created to select securities within the Parent Index for their recent price increases on the assumption that such increases will continue, there is no guarantee this objective will be achieved.
There can be no assurance that performance will be enhanced or risk will be reduced for [funds/strategies] that seek to provide exposure to certain quantitative investment characteristics ("factors"). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a [fund/strategy] may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.
Any opinions, forecasts should not be relied upon by the reader as research, investment advice or a recommendation. There is no guarantee that any forecasts made will come to pass.
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