MSCI Factor Focus: Momentum
FOCUS: MOMENTUM
Factor Investing msci.com FACTOR INVESTING
FACTOR FOCUS: MOMENTUM
IN THE REALM OF INVESTING, A FACTOR IS ANY CHARACTERISTIC THAT HELPS EXPLAIN THE LONG-TERM RISK AND RETURN PERFORMANCE OF AN ASSET. MSCI FACTOR INDEXES ARE DESIGNED TO CAPTURE THE RETURN OF FACTORS WHICH HAVE HISTORICALLY DEMONSTRATED EXCESS MARKET RETURNS OVER THE LONG RUN.
MSCI Factor Indexes are rules-based, transparent indexes targeting stocks with favorable factor characteristics – as backed by robust academic findings and empirical results – and are designed for simple implementation, replicability, and use for both traditional passive and active mandates.
DEFINING MOMENTUM The momentum factor refers to the tendency of winning stocks The MSCI Momentum Index measures: to continue performing well in the near term. Momentum is categorized as a “persistence” factor i.e., it tends to benefit • Risk-adjusted excess return - that which exceeds the from continued trends in markets (see “Performance and benchmark - for 6-month periods Implementation”). • Risk-adjusted excess return - that which exceeds the benchmark - for 12-month periods
WHY INSTITUTIONAL INVESTORS HAVE USED MOMENTUM STRATEGIES
Academics first identified the momentum premium in 1993, when that it is compensation for bearing high risk; others believe it may UCLA scholars Narasimhan Jegadeesh and Sheridan Titman be a consequence of market inefficiencies produced by delayed demonstrated that the strategy of buying stocks that have done price reactions to firm-specific information.2 well and selling stocks that have done poorly generated significant MSCI research shows, on a historical basis, the momentum factor positive returns over 3- to 12-month holding periods. has been one of the strongest generators of excess returns.
Many studies since then have found the momentum factor present The momentum factor has typically outperformed in a macro across equity sectors, countries, and more broadly asset classes.1 environment characterized by a long cycle in underlying market Momentum may not be as well understood as other factors, trends (see chart Macro Effects on Factor Performance on p6). although various theories attempt to explain it. Some postulate
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MSCI RESEARCH SHOWS, ON A HISTORICAL BASIS, THE MOMENTUM FACTOR HAS BEEN ONE OF THE STRONGEST GENERATORS OF EXCESS RETURNS.
MSCI.COM | 3 FACTOR INVESTING
PERFORMANCE & IMPLEMENTATION
Portfolio450 managers usually implement momentum by choosing stocks based upon their performance over the previous three to 12 months, omitting the most recent month to allow for short-term reversal effects. In MSCI’s simulated strategies W(seeORLD RchartISK WEIG below),HTED 400 both the 6- and 12-month approaches outperformed the MSCI World Index over the period November 1992 to MayWO 2015.RLD MOMENTUM WORLD EQUAL WEIGHTED RELATIVE RETURNS OF WORLD MOMENTUM STRATEGIES 250 350 WORLD MINIMUM VOLATILITY (USD) 700 150 800 30% 200 WORLD QUALITY 28.46% WORLD HIGH DIVIDEND YIELD 300 140 700 WORLD VALUE WEIGHTED 600 200 180 WORLD 25% 23.69% 250 600 n 20.72% 500 r 6M 130 n u r t 160 20% u e 150 200 t Performance R e 500 Combined e R 400 v
120 i e
t 15.21% 15.22% v
a 12M 14.64% i l 114500 15% t
400 e a R 12.50% l 100 u 110 e 11.62% 11.56% 300 v i m
t 100 10.14% u 300 a 9.42% l 120 9.16% 10% C
u 8.58% 7.70% 100 m 200 u 50 6.17% 200 C 5.42% 5.38% 50 100 4.04% 5% 3.39% 2.09% 100 90 100 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 80 0% 0 80 0 0 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Decile 1 Decile 2 Decile 3 Decile 4 Decile 5 Decile 6 Decile 7 Decile 8 Decile 9 Decile 10 4 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 9 9 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 HIGH SIZE LOW SIZE 0 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2 Annualized Return CAPM adj. Premium 2 Over time, individual factors have delivered outperformance relative to the market. Since March 2009, the MSCI World Momentum index ROE Quality EV D/E Bear Markets MSCI World MinVol/MSCI World (lhs) MSCI World (rhs) B/P Fwd E/P CFO/EV Combined has been the leading performer amongst the factor indexes. Over the period 2001-2016, despite there being a number of momentum 0.1 25% crashes, the momentum index has recovered swiftly and outperformed the five other factors discussed in this brochure series. 8.37% 8.49% 10 MSCI WORLD FACTOR INDEXES 0.08 7.74% 7.60% 7.75% 20% 7.03% 7.04% 450 ) % ( 15% 0.06 5.50% 5.60% d 400 l World Momentum r World Equal Weighted (Size) o
10% W 5 0.04 3.67% 3.80% 3.58% I 350 World Minimum Volatility C
3.21% S 3.05% 2.92%
World Quality M
5% World High Dividend Yield 2.36% 2.37% . s
300 v
World Value Weighted 0.02 n r
WORLD u 0% 0.73% 0.86% t 250 e R 0 e
0 v i -5% Decile 1 Decile 2 Decile 3 Decile 4 Decile 5 Decile 6 Decile 7 Decile 8 Decile 9 Decile 10 t 200 c Performance A
-10% -0.02 150 -1.96% Annualized Return CAPM adj. Premium -15% 100 -5 -0.04 Health Inf. Tech Industrials Materials Energy Cons. Cons. Financials Utilities Telecom. High Exp 2 3 4 5 6 7 8 9 Low Exp Care Stpls. Disc. 50 B/P Fwd E/P CFO/EV Combined 12% Unconstrained With Active Sector Exposure limited to 5% 10.44% 0 10.12% 9.72% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 10% 9.42% 9.28% 180 8.91% 8.92% 8.54% From a longer-term perspective, the simulated MSCI World Momentum Index has generated an annualized return of more than 13% 8.21% 160 during a 40-year period (see chart below). In comparison to other factor indexes over the same period, the momentum factor index 8% 140 tends to be at the higher end of the risk/return spectrum. 6.15% 6% 120 4 | MSCI.COM 3.84% 4% 3.60% 3.69% 100 2.98% 3.05% 2.62% 2.64% 2.67% 80 2% 0.62% 60 0.29% 0% 40 Decile 1 Decile 2 Decile 3 Decile 4 Decile 5 Decile 6 Decile 7 Decile 8 Decile 9 Decile 10 20 Annualized Return CAPM adj. Premium 0 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15
World Min Vol MSCI World FACTOR FOCUS: MOMENTUM
LONG-TERM PERFORMANCE: JANUARY 1976 TO DECEMBER 2016
15%
Value 14%
Momentum 13%
12% Yield Size
Annualized Return Quality
11% Volatility
MSCI World 10% 11% 12% 13% 14% 15% 16% 17%
Annualized Risk
Although factor strategies have exhibited long-term outperformance, in the short-term factor performance has been cyclical and has generated periods of underperformance.
HOW THE SIX FACTORS HAVE PERFORMED RELATIVE TO EACH OTHER: MOMENTUM
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
45.6% 1.5% -4.5% -9.6% 56.7% 28.6% 28.4% 31.0% 19.9% -29.2% 42.0% 18.2% 8.0% 16.7% 32.7% 12.1% 5.8% 10.3%
40.1% 1.2% -8.0% -9.8% 50.4% 24.1% 17.2% 28.9% 16.8% -33.5% 41.9% 16.5% 4.8% 16.5% 30.3% 9.0% 4.5% 9.4%
25.3% 0.3% -10.0% -13.6% 33.8% 21.3% 15.2% 22.1% 10.3% -39.9% 33.8% 12.8% 4.8% 15.0% 27.7% 7.0% 4.2% 8.9%
20.5% -2.1% -11.5% -14.4% 30.5% 20.8% 10.0% 21.2% 9.6% -40.3% 33.5% 12.3% 4.4% 14.8% 27.4% 5.5% -0.3% 8.2%
18.4% -10.2% -12.1% -15.1% 26.0% 20.0% 8.5% 20.7% 7.3% -41.9% 30.8% 11.4% -5.0% 13.7% 26.5% 4.6% -1.0% 8.2%
8.6% -12.9% -16.5% -16.5% 25.9% 15.2% 8.3% 19.1% 6.4% -42.4% 17.2% 9.1% -9.3% 13.3% 22.9% 3.4% -2.4% 5.1%
8.4% -18.9% -20.5% -19.5% 22.0% 12.7% 6.0% 16.8% 6.1% -42.6% 14.8% 7.2% -11.0% 8.9% 19.4% 3.3% -2.7% 4.7%
Volatility Yield Quality Momentum Value Size World
The analysis and observations in this report are limited solely to the period of the relevant historical data, backtest or simulation. Past performance — whether actual, back tested or simulated — is no indication or guarantee of future performance. None of the information or analysis herein is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision or asset allocation and should not be relied on as such.
The time periods covered in the charts in this paper were dictated by the data available when we conducted the simulations which produced them.
There are frequently material differences between backtested or simulated performance results and actual results subsequently achieved by any investment strategy
MSCI.COM | 5 FACTOR INVESTING
MACRO EFFECTS ON FACTOR PERFORMANCE
102.5
100.00
97.5
95.0 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15
Sharp decline Moderate decline Moderate uptick Sharp uptick
In general, factor performance has been cyclical in nature. Individual factors have been shown to outperform during different The Composite Leading Indicator used here, designed macroeconomic environments. As the charts on this page illustrate, to provide early-warning signals on business-cycle the momentum factor falls into the “persistence” category, meaning turning points, is an aggregate time series displaying that this type of strategy historically outperformed during stable a reasonably consistent leading relationship with the market conditions over the study period. reference series for the macroeconomic cycle.
In practice, momentum is typically combined with value to gain diversification benefits, due to the low and often negative correlation between the two factors.
Defensive Factors Persistence Pro-cyclical Factors 2%
1%
0%
-1% Quarterly Relative Return (Average) Relative Quarterly
-2% Volatility Yield Quality Momentum Value Size
Sharp decline Moderate decline Moderate uptick Sharp uptick
Data from November 28, 1975 to September 30, 2016.
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FACTOR FOCUS: MOMENTUM
MOMENTUM
CONCLUSION The momentum factor historically has produced long-term excess return, and several studies show that it has been present across asset classes, markets, sectors and industries. However, momentum strategies have sometimes been plagued by crashes and investability constraints. MSCI has developed a momentum index designed to target securities based on risk-adjusted performance, with the goal of mitigating momentum crashes and reducing unnecessary turnover.
FOOTNOTES & REFERENCES
1 Moskowitz, T.J. and M. Grinblatt. (1999). “Do Industries Explain Gupta, A., A. Kassam, R. Suryanarayan and K. Varga. (2014). Momentum?” Journal of Finance, Vol. 54, No. 4, pp. 1249–1290. “Index Performance in Changing Economic Environments.” MSCI Research. 2 Jegadeesh, N. and S. Titman. (1993). “Returns to Buying Winners and Selling Losers: Implications for Stock Market Gupta, A., I. Balint, Vipul Jain, Dimitris Melas. (2015). “Riding on Efficiency.” Journal of Finance, Vol. 48, No. 1, pp. 65–91. Momentum: Understanding Factor Investing.” MSCI Research .
Alighanbari, M., R.A. Subramanian and P. Kulkarni. (2014). Jegadeesh, N. and S. Titman. (2001). “Profitability of Momentum “Factor Indexes in Perspective: Insights from 40 Years of Data.” Portfolios: An Evaluation of Alternative Explanations.” Journal of MSCI Research Insight. Finance, Vol. 56, pp. 699-720.
Asness, C., T. Moskowitz and L. Pedersen. (2013). “Value and Martin, J.S. and B.D. Grundy. (2000). “Understanding the Nature Momentum Everywhere.” Journal of Finance, Vol. 68, No. 3, pp. of the Risks and the Source of the Rewards to Momentum 929-985. Investing.” Review of Financial Studies, Vol. 14, No. 1, pp. 29-78.
Bender, J., R. Briand, D. Melas and R.A. Subramanian. (2013). Rouwenhorst, G. (1998). “International Momentum Portfolios.” “Foundations of Factor Investing.” MSCI Research. Journal of Finance, Vol.53, pp.267-284.
Chan, K. N. Jeegadesh and J. Lakonishok. (1996). “Momentum Rouwenhorst, G (1999). “Local Return Factors and Turnover in Strategies.” Journal of Finance, Vol. 51, No. 5, pp. 1681-1713. Emerging Stock Markets.” Journal of Finance 54(4), 1439-1464.
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