Everybody knows that momentum investing works on average; stocks that have done well recently tend to continue to do well. This poses the question: are there any risks to such a strategy? The answer is yes.
To see this, let’s consider my no-thought momentum portfolio which comprises the 20 best-performing stocks from those with a market capitalisation of over £500m, rebalanced every quarter. Of course, this is only one of countless possible momentum portfolios. But we know from the work of Sheridan Titman and Narasimhan Jegadeesh that momentum’s good performance is robust to different specifications. It’s plausible therefore that what’s true of this portfolio is more or less true of other types of momentum strategies.
This portfolio – like almost all others – carries market risk. Since it began in 2004 it has had a beta with respect to the All-Share index of just over one. However, the regression equation that tells us this also tells us that momentum would have returned 9 per cent a year even if the market had been flat.