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1 November 2013 CFA Institute Journal Review

Value and Momentum Everywhere (Digest Summary)

  1. Paul R. Rossi

Joint analysis of value and momentum strategies across asset classes shows consistent evidence of positive return premiums while exhibiting significant co-movement within the respective strategy. The findings suggest the presence of common global factors that relate to both value and momentum.

What’s Inside?

The authors analyze the primary risk factors that affect both momentum and value strategies and how they are related. They address the correlation and variation between value and momentum strategies. Their analysis reveals significant return premiums as well as strong co-movement in both value and momentum strategies. Value strategies are positively correlated with other value strategies among otherwise unrelated markets, and momentum strategies are positively correlated with other momentum strategies among otherwise unrelated markets. The results indicate that value and momentum returns across vastly different asset classes are affected by common global factors.

How Is This Research Useful to Practitioners?

Although there have been other studies on value and momentum, they have primarily been focused on similar asset classes and have been conducted in isolation from each other. By looking at both value and momentum jointly across a broad range of asset classes, unique insights are revealed. The results indicate the possibility of common global factors that relate to both value and momentum and that cannot be found by examining a single market or strategy in isolation. Using a three-factor model consisting of a global market index, a zero-cost value strategy applied to all asset classes, and a zero-cost momentum strategy applied to all asset classes, the authors find the correlation and the cross section of average returns.

Their analysis reveals only a moderate link to macroeconomic variables (i.e., business cycles, consumption, or default risk). But they do find evidence that liquidity risk is highly correlated with momentum and negatively correlated with value among all the asset classes globally, although this result only partially explains the co-movement and return premiums found. The findings indicate that momentum and value load inversely on some common risk factors. Further research in this area might uncover additional risk factors that help explain these relationships.

The authors find significant return premiums in stock markets for all the markets studied. A stock portfolio that combines value and momentum shows a significant increase in the Sharpe ratio and outperforms either independent strategy for all markets. A simple equally weighted portfolio of value and momentum securities from all analyzed assets produces a Sharpe ratio of 1.45 while being resistant to liquidity risks. Additionally, the authors find new evidence for both momentum and value premiums in government bonds. They also find value premiums in currencies and commodities, which have not been previously examined. The abnormally large positive return premiums found in both strategies, coupled with their strong negative correlation, suggest that constructing a simple portfolio of the two strategies is closer to the efficient frontier than either strategy alone and should exhibit less volatility.

How Did the Authors Conduct This Research?

The authors examine eight globally diverse asset classes, placing each asset class into three equally weighted portfolios (high, middle, and low) for both value and momentum for a total of 48 test portfolios. These eight asset classes consist of individual stock portfolios in four markets: the United States, the United Kingdom, continental Europe, and Japan. The US and UK stock portfolios are measured from January 1972 to July 2011, whereas European and Japanese markets are studied from January 1974 to July 2011. The individual securities are restricted to extremely liquid and large companies. The remaining four asset classes consist of global equity indices, which are composed of 18 developed equity markets measured from January 1978 to July 2011, currencies of 10 countries covering a period from January 1979 to July 2011, global government bonds in 10 developed countries from January 1982 to July 2011, and futures that cover a broad range of 27 different commodities from January 1972 to July 2011.

To measure momentum among all asset classes, the authors use the past 12 months’ cumulative raw return on the assets and remove the most recent month’s return. To measure value for individual stocks, they use a common value ratio of book value of equity to market value of equity (book-to-market ratio). For other asset classes, value is more challenging because not all assets have a measure of book value, so the authors use simple and consistent measures of value, erring on the conservative side when establishing a value metric.

Abstractor’s Viewpoint

The joint examination of momentum and value strategies covering eight diverse markets and asset classes sheds new light on how they are related among various markets globally. The findings of seemingly unrelated markets that exhibit strong return premiums and co-movements within their respective strategies are quite interesting. Additional research could help determine how these findings might produce superior risk-adjusted returns for practicing investment professionals. The findings also present a challenge because current investment theories do not fully explain the observed relationships. Further research in this area might reveal additional common global factors that relate value and momentum strategies.

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