Momentum investing has become a key component of systematic equity strategies, attracting significant interest from financial allocators. Recent research highlights momentum’s robust characteristics and its evolving nature, making it essential for optimizing investment strategies.
Our analysis, covering over 150 years of data and numerous portfolio configurations, indicates that the momentum premium is both significant and consistent. This premium reflects a persistent return spread that has remained valid across various periods, locations, and investment styles, rather than being a mere statistical anomaly.
Table of Contents:
The enduring nature of momentum
The long-standing presence of momentum is perhaps its most notable feature, underscoring its importance for investors. For example, a straightforward long-short momentum strategy—buying past winners and selling past losers—could have transformed an initial investment of $1 into over $10,000 from 1866 to. This results in annualized returns of approximately 8-9%, a figure that is statistically significant, as indicated by t-statistics that surpass conventional reliability thresholds.
Robustness across varying conditions
This momentum phenomenon is notably unaffected by portfolio structuring methods. Whether employing value-weighted or equal-weighted returns, modifying the definition of momentum, or adjusting analysis timeframes, the premium remains resilient. This stability across different configurations reinforces the notion that momentum should be regarded as a fundamental characteristic of financial markets rather than a transient occurrence.
Complexity in momentum strategies
It is essential to recognize that momentum does not represent a single, uniform strategy. The performance outcomes tied to momentum are heavily influenced by the methodologies employed in portfolio construction. Factors such as the calculation of returns on a value-weighted or equal-weighted basis, the establishment of breakpoints, and potential industry-specific adjustments can significantly impact both return levels and associated risks.
Diverse portfolio configurations
To illustrate this sensitivity, we examined over 4,000 variations of momentum portfolios. Each variation produced positive Sharpe ratios, demonstrating the broad robustness of the momentum premium. However, the performance range was notable: the median Sharpe ratio was 0.61, with individual configurations varying from 0.38 to 0.94. These disparities emphasize the need for meticulous specification checks and transparency in factor design, especially in benchmarking or reporting results.
Expanding the concept of momentum
In recent years, momentum research has evolved beyond simple price trends. New methodologies have emerged that capture the ongoing nature of returns through different perspectives. For instance, fundamental momentum—driven by earnings surprises or analyst revisions—illustrates how investors often underreact to new information. Similarly, residual momentum focuses on company-specific return patterns, isolating the effects of individual news events and typically yielding smoother returns with higher Sharpe ratios.
Furthermore, concepts like industry and network momentum reveal both macroeconomic trends and firm-specific relationships, while factor momentum addresses persistent capital flows into certain investment styles. These alternative signals frequently exhibit low correlation with traditional price momentum, presenting valuable diversification opportunities.
Mitigating crash risks through strategic design
Despite its advantages, momentum investing faces potential crash risk. Strategies can be vulnerable to abrupt market reversals, especially during significant shifts in market regimes. Historical data indicates maximum drawdowns of up to -88% for conventional price momentum strategies, often accompanied by left-skewed return distributions.
Nevertheless, many alternative momentum signals exhibit lower volatility. When combined into a multidimensional composite, overall risk can be significantly reduced. By employing volatility scaling techniques at both portfolio and stock levels, it is possible to substantially decrease drawdowns while enhancing Sharpe ratios. This risk-managed momentum strategy can yield annualized returns nearing 18% with volatility levels comparable to standard momentum, effectively halving potential drawdowns.
Implications for investors
Our analysis, covering over 150 years of data and numerous portfolio configurations, indicates that the momentum premium is both significant and consistent. This premium reflects a persistent return spread that has remained valid across various periods, locations, and investment styles, rather than being a mere statistical anomaly.0
