While there is a probability that we are just seeing a departure from the past mean premium in momentum, I believe there are logical causes behind why momentum has been arbitraged away for good. Implementation costs have fallen, making the strategy accessible by more investors. ETF and mutual funds applying the momentum strategy are growing in numbers and assets under management, meaning that more money is chasing the same factor premium.
As momentum investing is a high-turnover and liquidity-demanding investing strategy, it means that we may be close to, or have already exceeded, the capacity for momentum investing. As access to computer power grows and implementation costs fall, all simple investing strategies will be arbitraged away. The momentum factor will not escape this fact. Our view is that momentum investing will disappoint going forward and the sharp rise in momentum funds everywhere is a frightening signal.
In Denmark, we are actually seeing momentum strategies being sold to the public on the leading benchmark index OMXC25. Think about this for a while.. the momentum factor is a broad-based premium that has held up over many decades (excluding the recent degrading), but when momentum is chased in a small subset of the total sample it becomes very speculative and likely data snooping – or fooled by randomness
, as Nassim Taleb would put it.
Let’s say that you invest in the 10 best-performing stocks in the OMXC25 based on some version of the momentum factor. What you are really betting on, then, is that out of the 5,000 stocks in the MSCI World Index these 10 shares, constantly rebalancedc will deliver consistent alpha. This is despite the fact that the broad-based momentum factor has shown sharp degrading.
Yes, the momentum factor can be implemented in different ways, but betting on a subset of 10 stocks out of 5,000 is to us a very high-risk strategy that could leave one chasing a mirage.
Again, simple strategies will be arbitraged away.