Value & Momentum

A Winning Combination

While proponents of both value and momentum investing appear to be at odds with one another, the negative correlation of the factors accounts for the reason they have proven to work best together.

The negative correlation between value and momentum strategies coupled with their high expected returns make a simple strategy of equally weighting a portfolio with value and momentum stocks a powerful strategy that produces higher cumulative long-term rates of return than either value or momentum alone (across every asset class). In addition, the combination of value and momentum results in a significantly higher Sharpe ratio than either a value or momentum strategy alone and makes the portfolio less volatile across markets and time periods.

The momentum effect around the world

The momentum effect around the worldSource: Large cap momentum portfolio returns from November 1990 to August 2012 (except for the US which starts in January 1927).

US factor premiums vs correlations

US factor premiums vs correlationsSource: David Blitz, “Strategic Allocation to Premiums in the Equity Market”, Journal of Index Investing, 2012.Correlations are calculated in excess of the market premium. The sample period is from July 1963 to December 2009.

“The momentum factor is one of the strongest
factors known to exist in equity markets around
the world and is used in many balanced ‘quant’
models. Momentum has a high factor premium
and as such can be an important source of
return for a factor portfolio.”

“Together with value, the
momentum factor has the highest return, well
above the market. In addition, the momentum
premium exhibits a low correlation with lowrisk
and value premiums.”

Source: “Robeco, The Investement Engineers, The momentum factor: the basics and Robeco’s solution, white paper, February 2013”

Returns on combination of value and momentum

The table below breaks all stocks into a 5×5 panel by value and momentum (6m return and price/earnings).  Stocks in the upper left have terrible value and terrible momentum.  Stocks in the lower right have great momentum and great valuations.  The combination of these concepts has been very powerful.

Returns on combination of value and momentum

Source:  Patrick O’Shaughnessy

Combining Value and Momentum delivers superior performance!