As an investment concept, the idea has been around for about as long as organized securities markets have been operating. Momentum-based trading advice dominates the famous 1923 book Reminiscences of a Stock Operator, which says the trend is your friend. And the bull market of the 1960s brought the first wave of momentum-influenced mutual funds, inspired by the trading successes of money manager Gerald Tsai. John Brooks famously chronicled this era in his best seller, The Go-Go Years.
In the modern era, academic research on momentum begins with a 1993 paper in the Journal of Finance by Narasimhan Jegadeesh and Sheridan Titman, who showed how buying stocks that have performed well in the past and selling stocks that have poorly performed in the past can win an investor significant returns over three-to-12-month periods (in their now famous report titled, Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.)
Professors Eugene Fama and Ken French cited the momentum factor as an "embarrassment" for their own popular three-factor asset pricing model, which identifies small and value stocks, along with the overall market, as the primary risk factors driving equity returns. Fama and French couldn't explain the success of momentum investing, even if they did acknowledge its existence.
One researcher, Mark Carhart, a finance professor and former managing director of the quantitative strategies group at Goldman Sachs, took the hint and simply added momentum to Fama and French's three-factor model, coming up with a four-factor approach that he outlined in a 1997 study. Carhart decided that a richer framework for deciphering stock returns would require researchers to look to momentum and place it in the context of value and small-cap effects, along with the broad market beta.
"Momentum is ubiquitous across all major asset classes," says professor Craig Pirrong at the University of Houston, summarizing the conclusion in one of his own research efforts.
A similar finding echoes throughout the analysis of Mebane Faber, a portfolio manager at Cambria Investment Management. His work demonstrates that momentum investing's close cousin-trend following-has proved its worth as a risk management tool in connection with tactical asset allocation. Faber's research showed that using the buy and sell signals generated with simple ten-month moving averages in a portfolio of five asset classes dramatically lowered overall volatility without sacrificing return (in this case, the classes are represented by indexes for domestic and foreign stocks, U.S. Treasurys, REITs and commodities). He explains in his book The Ivy Portfolio that managing a mix of asset classes using only moving averages can help an investor achieve a high Sharpe ratio (in other words, relatively high performance for the amount of volatility) when measured over several decades and compared with a buy-and-hold portfolio of the same assets.
Faber calls momentum one of the timeless sources of benchmark-beating return. Why does this particular alpha endure? The answer is bound up with investors' behavior-the byproduct of greed and fear, he says.
Taking a page from Carhart and the four-factor model, researchers have thus continued to combine momentum-based strategies with other factors. For instance, a forthcoming study in the Journal of Portfolio Management reviews the benefits of combining momentum and value strategies in a global tactical asset allocation portfolio. "Momentum and value strategies applied to [such a portfolio] across 12 asset classes deliver statistically and economically significant abnormal returns," write David Blitz and Pim Van Vliet in the report, Global Tactical Cross-Asset Allocation: Applying Value and Momentum Across Asset Classes.
Meanwhile, Shafiq Ebrahim, a researcher with Aronson+Johnson+Ortiz (AJO), a value-oriented quantitative money management firm in Philadelphia, explains, "Academic and practitioner research has shown pervasive support for the profitability of momentum strategies across several markets/asset classes."
No wonder that momentum is routinely cited as a central force in managed futures strategies, which cast a wide net across asset classes, including equities, bonds, commodities and currencies. "Momentum is the dominant component of performance for the managed futures industry," says Pat Welton, CEO of Welton Investment, a managed futures shop in Carmel, Calif., with $500 million under management.