Cliff Asness

Instead of mixing value and growth stocks, investors would be far better served by combining value and momentum stocks, according to Cliff Asness, co-founder and Managing Principal of AQR Management. 

In fact, momentum has “kicked butt” when compared to growth over the last 80 years, Asness said.

Asness, who has a PhD from the University of Chicago and did his thesis on momentum, delivered his remarks at a breakout session at last week’s Schwab Impact Conference.  His firm recently introduced a series of indices and mutual funds aimed at allowing investors to gain low cost, passive exposure to momentum, and his talk detailed the theory underpinning and historical evidence supporting his momentum strategy.

Momentum was first identified by academic researchers in the early 1990s. It is the phenomenon that stocks – as well as other asset classes, according to Asness – that have done well in the recent past tend to do well in the future.  Those that have done poorly are more likely to continue to underperform. 

The over- or underperformance associated with momentum is measured relative to a benchmark, although Asness said that momentum has also performed well on an absolute basis.

Momentum is negatively correlated (-0.5) to value, and it makes sense alongside value in a portfolio.  Such a strategy produces better risk-adjusted returns than a combination of value and growth, Asness said.

Momentum has a positive (0.4) correlation to growth.

The basis for momentum

For momentum to be a viable strategy (and to be considered a viable “factor” alongside growth and value), it must pass three tests:

  1. It must be pervasive and “work” (outperform relative to a benchmark after adjusting for risk) across a variety of asset classes and markets.  Asness offered data showing that momentum has in fact worked in small- and large-cap stocks, within industries, in US and non-US markets, within specific countries and among commodities and currencies.
  2. It must not be “subsumed” by other styles.  Momentum would be useless if it could be explained by following either a growth- or value-oriented strategy or by a market-cap-based strategy.  Technically, this means that momentum generates alpha when tested against the Fama-French three-factor model. 

    For example, a researcher once posited that outperformance could be achieved by purchasing those stocks which had done poorly over a five-year period.  It was later shown, however, that his strategy merely picks up on the value bias: stocks that do poorly tend to be value stocks. 

  3. It is more growth-like than value-like, but it is neither one. Momentum stands apart as an independent risk factor.

Choosing the right time frame is critical, and Asness said that stocks that outperformed over the last 12 months are those more likely to continue to outperform.  It is important, however, to wait a month before choosing those stocks, because month-to-month stocks tend to reverse themselves.  “If you act too quickly, the market tends to overreact,” he said.

Countering the claim that his choice of 12 months amounts to data mining and that momentum is just picking up on a random effect, Asness said that many out-of-sample studies of momentum across other markets and asset classes confirm the underpinnings of his theory.  Momentum has as much out-of-sample evidence as the value effect, for instance.