Does momentum investing work?
Source: Callen Associates
Investors have a tendency to chase returns. That’s why mutual fund companies hype their most recent performance in big, bold letters, just above the fine-print disclaimer: “Past performance does not guarantee future results.” There’s a reason they advertise this way: everyone loves a winner.
It’s not just individuals who do this. A couple of business school professors analyzed 1000 pension fund target allocations over a 20-year period and found that the typical fund chases returns for several years, to the detriment of the plan. Momentum investing works for about a year, they found, and then the asset’s performance moves in the opposite direction.
Why does this happen? Investors are always looking for the next world-changing idea to lift their portfolios. Money floods into a promising concept until it’s priced for perfection. But nothing fails like success: when the world doesn’t change, those hefty valuations fall back to earth. That’s why tech stocks underperformed from ‘01 to ’04, and China’s market has lagged more recently.
Shakespeare once wrote, “There is a tide in the affairs of men which … leads on to fortune” (Julius Caesar IV.iii). Ironically, the character who said that had missed his tide and was headed for a fall. Often, the best way to profit from momentum is to go against the flow.
Douglas R. Tengdin, CFA
Chief Investment Officer
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