Among the many factors cited in academic research, only a handful have been sufficiently reliable for use in asset pricing models. One of those is momentum. The evidence has been robust for not only cross-sectional (relative) and time-series (absolute or trend) momentum, but also for factor momentum. New research shows that it works globally – even in China, a country whose markets have not historically exhibited momentum.
To determine which exhibits in what John Cochrane famously called a “zoo of factors” are worthy of investment, in our book, Your Complete Guide to Factor-Based Investing, Andrew Berkin and I laid out the following criteria: For a factor to be considered, it must meet all of the following tests. To start, it must provide explanatory power to portfolio returns and have delivered a premium (higher returns). Additionally, the factor must be:
- Persistent – It holds across long periods of time and different economic regimes.
- Pervasive – It holds across countries, regions, sectors and even asset classes.
- Robust – It holds for various definitions (for example, there is a value premium whether it is measured by price-to-book, earnings, cash flow or sales).
- Investable – It holds up not just on paper but also after considering actual implementation issues, such as trading costs.
- Intuitive – There are logical risk-based or behavioral-based explanations for its premium and why it should continue to exist.
Out of the hundreds of exhibits in the factor zoo, one of the just five equity factors that met all the criteria was momentum. Recently, factor momentum has received much attention from researchers. The empirical research on factor momentum factor, including the 2018 studies, “Factor Momentum Everywhere,” and, “Is there Momentum in Factor Premia? Evidence from International Equity Markets,” the 2019 studies, “Factor Momentum and the Momentum Factor,” and, “Factor Momentum,” the 2021 study, “Is Factor Momentum More than Stock Momentum?”, and the 2022 study, “Momentum-Managed Equity Factors,” has examined whether momentum can be found in factors as well and found:
- Time-series (trend) factor momentum has been a pervasive property of factors – a strategy that buys the recent top-performing factors and sells poor-performing factors achieved significant investment performance above and beyond traditional stock momentum.
- Factor momentum explained all forms of individual stock momentum – stock momentum strategies indirectly timed factors; they profited when the factors remain autocorrelated and crashed when those autocorrelations break down.
- Demonstrating pervasiveness, factor momentum has been a global phenomenon.
- Factor momentum could have been captured by trading almost any set of factors.
- Industry momentum stemmed from factor momentum.
- The value-added induced by factor management via short-term momentum was a robust empirical phenomenon that survived transaction costs and carried over to multifactor portfolios – while managing factors based on last month’s momentum increased turnover, the increase in turnover induced by timing did not outweigh the benefits of timing. In addition, turnover could have been reduced using a smoothed version of the timing signal, and timing still yielded significant benefits.
Further support for factor momentum was provided by Mamdouh Medhat and Maik Schmeling, authors of the study, “Short-term Momentum,” published in the March 2022 issue of The Review of Financial Studies (an older version can be found here). They found that while, in aggregate, stocks have exhibited negative short-term (one-month) momentum, the well-documented one-month reversal anomaly was fully explained by the negative performance of low-turnover stocks – their winner-minus-loser strategy within the highest turnover decile returned 1.37% per month (t-stat = 4.74), evidence of strong continuation in one-month returns for high-turnover stocks. Thus, we can conclude that factor momentum and stock momentum in high-turnover (the top three deciles of liquidity) stocks has been positively correlated.
These findings support the conclusion that momentum among equity factors has been a pervasive phenomenon in financial markets. Tian Ma, Cunfei Liao and Fuwei Jiang provide another test of the pervasiveness of factor momentum with their June 2022 study, “Factor Momentum in the Chinese Stock Market.”
