In this Wiki we will describe the different Terms related to Momentum Investing and highlight the important Dimensions important for the due diligence.
Gary highlight three key factors in structuring a momentum program:
A. Look-Back Period indicate over what period the Momentum is being measured. In the paper "Newfound’s Dynamic Momentum" it is highlighted how Strategies with a Dynamic look-back window, has the ability to reduce turnover.
B. The chosen universe of available investment opportunities ie. individual Stocks, Sectors or Asset Classes.
C. Quantity of Positions
D. Momentum Algorithm Variant
The Momentum Factor comes in many flavours, and It is important to look at the Algorithm delivering the Momentum proxy. Is the Momentum just proxied as the total return over the chosen look-back period, or is it adjusted in some way.
The company Robeco has a strong Research Team, engaged with researching and producing innovative Smart Beta and Momentum products.
The Team in their paper “The momentum factor: the basics and Robeco’s solution” highlight how conventional Momentum Strategies tend to contain high-beta stocks, because these stocks earn the highest returns in a bullish environment, where high beta stocks outperform the market. This is an important return detrimental when the market reverse, since the high-beta stocks will be the biggest losers, while low-beta stocks become the new winners.
Robeco solution is a Residual Momentum Methodology available in a Mutual Fund format, that adjust the Momentum Proxy for the dynamic Fama & French Factor exposures resulting in dramatic decrease in Risk.
I think the Robeco methodology does a good job at highlighting how construction methodologies evolve based on research, and has prompted me to define the Fourth Dimension in the Momentum due diligence
D. Momentum Algorithm Variant - defined to highlight what type of algorithm really delivers Momentum proxy.
So as it stands there are currently two ways a Momentum Strategy can be improved.
A. Through a Dynamic Look-Back Window
B. Adjusting the Momentum Score for Return associated to Systematic Beta Risk factors.