Throughout the great rise of the fund management industry, funds have been categorised by agencies such as Morningstar as either having a ‘Growth’ or ‘Value’ bias or some blend in between. Yet in just over 20 years, the pursuit of ‘Momentum’ – buying shares on rising prices on the basis that they will often go on to rise higher – has become a popular and increasingly well-researched approach. Momentum, it’s been argued, does a far better job than growth. So much so, that the argument in support of buying growth stocks as an equity style at all has been called into question.
The essence of this argument was proposed in a 2009 document by US investment group AQR Capital Management. In it, AQR banged the drum about the notable absence of momentum on the investment landscape and introduced a Momentum Index to not only prove its point that growth investing could be bettered but also to provide asset managers with a momentum benchmark. While AQR was probably keen to sell a new fund on the back of this index launch, to give them their dues, some of those behind the launch had been influential contributors to the thinking behind momentum right from the start.
Cliff Asness, the ex-Goldman Sachs analyst and founder of AQR, was one of a number of researchers behind a 2009 paper called “Value and Momentum Everywhere”. Among his co-writers was Tobias Moskowitz, an academic that has written at length on momentum (and who also wrote the AQR research). Their paper concluded that value and momentum worked so effectively together that investors should seek to blend the two strategies:
“The negative correlation between value and momentum strategies and their high expected returns makes a simple equal-weighted combination of the two a powerful strategy that produces a significantly higher Sharpe ratio than either stand alone and makes the combination portfolio far more stable across markets and time periods than either value or momentum alone.”
In the AQR research that followed the academic work, the argument made was that whichever way you looked at it, chopping growth stocks out of a portfolio and introducing momentum produced superior returns and improved Sharpe ratios.
What is a Sharpe ratio?
Sharpe ratios are a byword for risk-adjusted returns. Developed by US finance professor William Forsyth Sharpe, you calculate the ratio by…
