1  Portfolio Equity

Momentum

What is it? And is there an Alpha?  Nobody can be a bigger critic to generation of alpha than Eugene Fama, the father of EMH (Efficient market hypothesis). His whole hypothesis is based on the maxim that you cannot beat the markets.

Despite being COMMITTED to his theory, he confessed in following words.

 

“Momentum is the premier anomaly, Stocks with low returns over the past year tend to have low returns for the next few months, and stocks with high past returns tend to have high future returns.  -Fama and French.

 

 

The reason why it is not a known anomaly is that it is rather difficult to explain compared to let us say Value Investing, which makes immediate intuitive sense because you are buying something below its ‘Intrinsic value and selling it above or at that value following the revert to the mean philosophy.

 

The momentum factor is based on buying high and selling higher. It is that time span in a script’s life when it zooms up before revert to the mean syndrome kicks in.

 

Another reason why this anomaly has been frowned upon is because of extensive marketing done by your friendly next door mutual fund which considers chasing performance as a SIN.

 

Momentum is that ‘SIN’ with a pre-defined entry criterion and exit strategy.

 

Revert to the mean happens, there is no doubt about that, however that plays out over a business cycle of 03 years. In the meantime, what goes up, keeps going up and what goes down keeps going down and once in a while, you come across an outliers stock which goes berserk and changes your portfolio forever.

 

 

Now broadly speaking, momentum can divided into 03 Sections and how academic research has shaped up in this field.

 

First one is the age old trend following, It is not necessarily momentum as it is very LONG TERM in nature and looks to capture the BIG moves.

Invariably this works to have a lot of small losers and then one BIG mother of a BIG move. These big trends usually happen  in currency and commodity.

 

Second sect is the rule based momentum strategies applied to Index itself. The rotation is done based on relative strength and a trend following overlay is introduced to cut down the draw-down.

 

Gary Antonacci has done some pioneer work in this field. Also Part of it is what Wesley Gray proposes in his wonderful book, Quantitative momentum.

 

We at Mystic Wealth while admire the work of above authors, are NOT interested in either of the above. You see Dual momentum on various asset classes is wonderful strategy if you are already rich and are interested in maintaining the status Quo.

 

However, if you are NOT rich yet, you cannot afford to miss the Outlier effect of SUPER ZOOMING STOCKS. And the proposed method of Wesley, while powerful still has a lot of academic tinge to it and plays a little too safe for our comfort.

 

What we do here at Mystic Wealth comes in the third category. Applying momentum to a basket of super stocks. This is what we strive to do here at our momentum portfolio.

The idea is to get rich or die trying. Well not actually dying, that was just a phrase as we are not putting ALL our chips into this basket. As a Savvy investor you need to put some % of your entire net-worth in this strategy to give yourself OPTIONALITY.

 

Consider this as an OTM Option, which might explode and turn elusive financial Independence dream to reality. And that is the bottom line s it not. You don’t want to reach there when it is time to leave.

That is like ordering steak with no teeth to dig in

 

 

What Do We Do. 

 

Without disclosing the exact mechanics of our system, let us just say our selection universe is done systematically following a code, lets say 52 week high. (it is a little heavy than that, but still very simple)

 

we further narrow down our selection by ranking stocks on the basis of their SCORE. (A combination of past performance, volume, smoothness etc). From here on, we simply ride our winners and cut our losers following an inhouse TF system.

 

Now intuitively we know that such a system would work only in bull markets and therefore we have a trend following overlay which tells us if it should be in the market or not.

 

We have backtested* the robustness of the system and it passes our stringent benchmark. So while it would struggle in 2011 environment, it would ride the 2003-2007 rally, save u from 2008 crash and would blast to the moon in 2014-2017 environment.

 

EXPECTATION SETTING.

To say we will come out unscathed in all situations would be fool hardy. Find below the underwater equity report for your perusal and evaluation.

 

 

2_ Underwater Equity

 

 

As you can see, despite having a trend following overlay, year 2008 resulted in a drawdown of 30%.

 

02 important points need to be kept in mind as far as draw downs are concerned.

  1. Withstanding a 30% drawdown is at least 3 times more difficult in reality Vs intellectually.
  2. Actual drawdown, invariably is always bigger than the worst you have seen before.

 

As if drawdown devil was not enough to scare you, the second devil is of SHEER STAGNANCY.  Year 2011 was a negative year and literally nothing happened in Indian markets. It can be a crazy wait and inaction as you can see below in the year table.

 

3_ Profit Table

 

If you are still reading this, now let me share the final graph of how the strategy has performed. Take it with a pinch of salt that 2014-17 has been a dream run and you don’t get these Runs every day. Having said that, if India story has to play out and BIG BULL RUN has to happen, we will have many more such years and runs in future and hopefully MWM (MysticWealth Momentum ) will be well positioned and  ready to NAIL it

 

 

1_ Portfolio Equity

 

 

Few Points.

Starting capital was 1 million.

A little less than 1000 trades were executed in this 11 year backtest.

20 positions with 5% capital. (very concentrated for momo, too diversified for value)

Worst draw-down was year 2008

Due to the nature of momentum, you would incur 15% short term tax on almost all your winners.

The figure includes brokerage  and slippage and does not include dividends if any.


 


 

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