MOMENTUM ACROSS ASSET CLASSES Loes van der Poel (207332) Bsc. Tilburg University A thesis submitted in partial fulfilment of the requirements for the degree of Master of Science of Finance. Tilburg School of Economics and Management Tilburg University Supervisor: Prof. Lieven Baele Second Reader: Prof. Adri Verboven November 29, 2019 1 Abstract This thesis focuses on analysing the impact of momentum on a multi-asset portfolio, consisting of: equities, currencies government bonds, corporate investment bonds, corporate high-yield bonds, commodities and a real estate index. The profitability of asset-class momentum strategies is analysed by using actual price data on indices of the aforementioned asset classes. The approach that was introduced by Jegadeesh and Titman is applied to assess the success of momentum strategies across asset classes. Eight strategies were investigated and the results add convincing evidence in favour of multi-asset momentum profitability. The momentum strategies generate abnormal returns, during the period 1995-2018, ranging from 6.79% to 11.45%. Strategies that employed shorter formation periods were found to be more successful during this sample period. A multi-asset momentum strategy can thus be beneficially exploited, implying that momentum is indeed present across asset classes. 2 Table of contents Introduction ............................................................................................................................................. 4 1. Literature review ............................................................................................................................. 6 1.1 Momentum within asset classes .............................................................................................. 6 1.1.1 Momentum in Equity ....................................................................................................... 6 1.1.2 Momentum in exchange markets ..................................................................................... 8 1.1.3 Momentum in commodities ............................................................................................. 9 1.1.4 Momentum in bonds ...................................................................................................... 10 1.2 Momentum across asset classes............................................................................................. 10 1.3 Explaining momentum .......................................................................................................... 11 2. Data and Methodology .................................................................................................................. 13 2.1 Data ....................................................................................................................................... 13 2.2 Methodology ......................................................................................................................... 15 3. Empirical results ............................................................................................................................ 19 3.1 Returns of Trading Strategies ................................................................................................ 19 3.2 Performance statistics on momentum returns ........................................................................ 22 3.3 Systematic biases ................................................................................................................... 23 3.4 Momentum during subperiods ............................................................................................... 24 3.4.1 Sample period divided ................................................................................................... 24 3.4.2 Momentum during recession ......................................................................................... 25 4. Robustness tests ............................................................................................................................. 26 4.1 Momentum of volatility adjusted returns .............................................................................. 26 4.2 Transaction costs ................................................................................................................... 26 Conclusion ............................................................................................................................................. 28 Bibliography .......................................................................................................................................... 30 Appendix ............................................................................................................................................... 34 3 Introduction On October 29, 2010, JP Morgan launched a multi-asset, long-only momentum index: the J.P. Morgan ETF Efficiente 5 Index. This index allocates capital between twelve asset classes and a US$ index based on their price momentum during the past six months. On December 28, 2016, JP Morgan launched another multi-asset, long-only momentum strategy: the JP Morgan Mozaic II index. This strategy similarly holds six out of twelve assets based on their past six month performance. The two strategies operate different risk management methodologies. However, they both rely on the hypothesis that the theoretical foundation for observed momentum effects may hold across asset classes as well. JP Morgan believes that these indices provide a diversified asset allocation that will generate stable returns. The fact that JP Morgan sees potential in multi-asset class allocation based on momentum signals raises questions on the potential for momentum investing across asset classes. Momentum is the empirically observed proclivity of assets to maintain recent price trends in the future. The intuition behind this market anomaly is straightforward as it logically assumes that assets that have performed well in the recent past will continue to do so and vice versa. Price momentum strategies aim to exploit such a trend by buying assets that have recently appreciated and selling the ones that have recently declined. That kind of trading strategy would be profitable if and only if price momentum exists. The occurrence of a momentum effect effectively defies one of the cornerstones in traditional finance theory, namely the efficient market hypothesis. As it suggests that historical prices can be used in order to predict future performance, this would enable investors to consistently outperform the market. Momentum is a style factor. Style factors are traditionally defined as characteristics that persistently explain returns within asset classes, whereas so-called macro factors are supposed to capture effects across asset classes. Price continuation was first documented for equity, Levy (1967), Jensen and Benington (1970) and Jegadeesh and Titman (1993) developed various methods for selecting stocks based on their relative strength. The methodology of Jegadeesh and Titman (1993) was subsequently adopted as the leading methodology to compose momentum portfolios. Since 1993 consecutive articles, on momentum in a variety of asset classes, have been published. Apart from equity, momentum effects have been documented for commodities ((Erb & Harvey, 2006), (Miffre & Rallis, 2007) and (Fuertes, 4 Miffre & Rallis, 2010)), fixed income (Asness, Moskowitz & Pedersen, 2011) and currencies (Okunev & White, 2003) and (Menkhoff, Sarno, Schmeling, & Schrimpf, 2012)). The evidence of momentum in this wide variety of asset classes has motivated the multi-asset approach conducted in this thesis. The main goal of this research is thus to analyse whether an investment strategy based on momentum across asset classes is worthwhile. Consequently, this paper will aim to prove a consistent excess return premium that can be achieved if the above-mentioned strategy is put into practice. The remainder of this paper is organized as follows: Chapter 1 contains a literature review of momentum within each major asset class and summarizes the relevant literature on momentum across asset classes. Chapter 2 elaborates on the data collection procedure and the methodology of the empirical analysis. Next, Chapter 3 delivers the empirical results and the corresponding implications, while Chapter 4 addresses a variety of robustness checks. Finally, Chapter 5 is concentrated on concluding remarks. All tables and graphs that are referred to can be found in the appendix, starting from page 34. 5 1. Literature review 1.1 Momentum within asset classes The majority of studies regarding the momentum anomaly have focused predominantly on equity momentum. Additionally the momentum effect has been proven to exist within various other asset classes as well as across asset classes. The contents of this sub-chapter are divided such that section 1.1.1 illustrates the evidence for momentum within equity, section 1.1.2 reviews the academic literature on momentum in currencies. Section 1.1.3 will expand further on momentum in commodities and finally section 1.1.4 will conclude with a review on momentum in bonds. 1.1.1 Momentum in Equity Jegadeesh and Titman (1993) laid the groundwork for the momentum strategy as it is currently known. In their paper they found that statistically significant abnormal returns could be realized by buying US stocks that performed well over a recent period and selling US stocks that performed poorly over the same period. The results were tested for systematic