Bodies In Motion

Ultimately, such differences influence the end result. All momentum strategies, in other words, aren't created equal, as a new study reminds us. A recent research paper co-authored by Hong-Yi Chen analyzes three momentum trading rules for equities according to price, earnings and revenue, reviewing how the three vary in terms of persistence and magnitude to generate an excess return through time (the study is called "Price, Earnings, and Revenue Momentum Strategies," available at SSRN.com)

AQR defines momentum for its three index funds as the top one-third of stocks in the target universe (large-cap U.S. stocks, for instance) ranked by performance over the past 12 months. The benchmarks are reconstituted every three months to keep the indices populated with recent winners.
Momentum, after all, is somewhat ephemeral as risk premiums go. Although the general effect endures, it requires a fair amount of maintenance through trading for an investor to capture the beta as a long-term proposition and thus beat plain vanilla index strategies based instead on market cap.

"The implementation of a momentum strategy involves significant costs because such portfolios tend to contain stocks that are relatively more expensive to trade," Ebrahim warns. "It is unlikely that [a momentum] strategy would be profitable in the absence of careful management of transaction costs." That doesn't deter AJO, AQR and other shops, but it does keep them humble and focused on costs. Or at least it should.

All things being equal, the stakes are higher for portfolio managers using momentum relative to more familiar risk premiums. Why? Successful momentum investing requires a deft hand. That inspires the question: Is the extra work worth the effort?

The historical studies say yes. But analyzing the past is one thing; showing real world results is something else. Momentum investing has clearly been a strong source of return for a number of active managers. It also casts a long shadow across the encouraging track record of managed futures as an industry. With the advent of AQR's index funds, a new era dawns for using momentum as a stand-alone strategy and, arguably, in a passive way. But it doesn't come cheap, at least by indexing standards. The new AQR funds carry net expense ratios of 49 to 65 basis points. That's quite reasonable for active management, though investors will look twice at the price in a marketplace where some ETFs offer broad equity betas for less than 10 basis points.

As for experimenting with new risk factors in public funds, we've been here before. In the early 1980s, for instance, there was hope for the newly recognized power of the small-cap premium. In the following decade, small-cap value earned an academic blessing. In both cases, new products arrived soon after to exploit these academically sanctioned ideas. As a general proposition, both have worked out well, albeit with varying results.

Will a similar fate bless momentum with the mass audience? Stay tuned.