Secrets of Its Success
At a glance--and if "momentum" weren't in the fund's name--you might conclude its recent success owes to a big bet on energy stocks. Which it does. Sort of.
At the end of March, energy accounted for 27.5% of the AQR fund's assets--more than double the benchmarks' exposure. That big weighting doesn't reflect management's views on the sector, though. The team overseeing the fund doesn't override the quantitative inputs. Rather, the portfolio is composed of the top third of domestic large- and mid-cap companies as ranked according to their share-price performance during the preceding 12 months. If that leads to a sector overweighting, they won't bring it back in line. (For the full scoop on the fund's strategy, click here
for my colleague Janet Yang's latest analysis.)
Tech companies are plentiful, too. But with energy the best-performing area of the market during the last year, it's not surprising to find the sector well-represented in the fund's portfolio. Also no surprise is that AQR Momentum ranks among the category's poorest performers during the last month, a stretch in which energy stocks as a group have tanked.Reversal of Fortune
As that example illustrates, momentum investors can quickly find themselves in the wrong place at the wrong time when what was working suddenly stops. Yet notwithstanding the occasional downward lurch, price momentum has generated substantial excess returns over the long haul -- at least on paper.
A white paper published last year by GMO quant Tom Hancock (one of our upcoming panel's participants) revealed that, between 1927 and 2009, a strategy similar to the one in play at AQR Momentum would have outperformed the broad stock market at an annualized clip of 4%.
Past isn't necessarily prologue, but that's an impressive track record. And of course for those inclined to hedge a momentum bet in hopes of avoiding the tactic's inflection-point vulnerability, it's always possible to use momentum (which comes in flavors other than AQR's price approach) as simply one more tool in a wider-ranging investment approach.
That's the practice at the fund shops founded by our panel's other participants, Steve Leuthold, of Leuthold Weeden Capital Management, and John Montgomery, who hails from Houston-based Bridgeway Capital Management.Possible, Yes. Advisable?
Montgomery's firm provides a particularly interesting case study right now of momentum's compatibility with other rules-based approaches. While the shop's long-term profile remains solid (and in some cases exemplary), Bridgeway has had a tough time in recent years, including in 2010. That's partly because the more fundamental factors its models consider have steered the shop away from the riskier stocks that have fared best amid the market's rally.
While Bridgeway keeps the details of its quantitative models under wraps, it's known that momentum is among the factors they screen for. At least at a glance, that would seem to make the firm's underperformance last year--generally a good one for momentum--somewhat disappointing: Of the 11 Bridgeway funds that were up and running during the full year, only two made it into the top half of their respective categories.
Adding to the intrigue is that Bridgeway's firmwide holdings bear resemblances to those of the purer-play AQR fund.
As with that offering, ConocoPhillips
make the shop's top 20, for example. True, the firm appears dramatically light on energy relative to the AQR offering. But Bridgeway actually sports a modest overweighting compared with the Russell 2000 and Russell 2000 Growth indexes, more relevant benchmarks given the fund family's smaller-cap orientation. (Seven of its 13 funds are small-cap vehicles; two others land in the mid-growth square of the Morningstar Style Box.)
Also as with the AQR fund, tech companies are prominently featured. IBM
rank among Bridgeway's firmwide top 10, for example, while Apple
--AQR Momentum's top holding--ranks among Bridgeway's biggest positions, too.Not a Matched Set
There are several key differences between Bridgeway and AQR Momentum, though.
Momentum is just one of several factors in the shop's models, for example, and price momentum (the variant of the tactic that AQR employs) plays a role in just one of its funds-- Bridgeway Small-Cap Momentum
. The firm places a premium on risk management, too, using models that aim to account for (among other things) downside risk, valuation attractiveness, and fundamental health.
All told, the current firmwide result of Bridgeway's quant work is a lineup whose aggregate price multiples fall below those of the broader stock market's and whose typical holding boasts above-average financial health, as gauged by debt/capital. Bridgeway's overall beta roughly aligns with the broader market's.
Amid the flight to risk that's paced the market's rally during the past two-plus years, those attributes haven't been in vogue. Lower-quality, speculative fare (which Bridgeway has scant exposure to) has led the way. Performance at the firm has perked up lately, but for an extended period, the shop's returns suffered despite the benchmark-besting success its models had identifying companies that, subsequent to a Bridgeway fund purchasing them, went on to exceed Wall Street's earnings forecast. Indeed, as the firm notes in its latest quarterly report, in some cases, the better a fund did on that score, the worse it fared versus its benchmark.The Big (Mo) Question
Can momentum play nice with other strategies, serving (for example) as a complement to more fundamentally focused inputs?
Depending on the market environment it's deployed within--and depending on investors' time frames as well--the answer appears to be: Yes, but. Irrespective of what the shop may have gained lately via momentum, after all, Bridgeway's models tilted it toward fundamental overachievers whose economic success hasn't been well-rewarded relative to riskier fare. Chase Growth
--a fund whose bottom-up, quality-biased managers also use momentum--has suffered a similar fate. That fund boasts a solid long-term track record, though, and Bridgeway's oldest offerings-- Aggressive Investors I
and Ultra-Small Company
, which launched in 1994--reside in the fourth and first percentiles of their respective categories during the trailing 15-year period.
The upshot is that taking advantage of momentum's historical tendency to outperform requires patience and discipline. During some periods, other factors in play at funds that use the tactic can work at cross purposes, too. Over the long haul, though, there's evidence to suggest, that momentum can indeed be a powerful supplement to a wider-ranging investment philosophy.