What is it? And is there an Alpha? We at MysticWealth follow a simple rule. If your competitor says you are good, you must be doing really well. Nobody can be a bigger competitor 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. And you have to smell the sweet smell of alpha when he confesses.
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 chasing 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 are 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 drawdown.
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.
We run a concentrated algorithm driven 20 stocks portfolio and manage it dynamically. We have back tested the efficacy and robustness of the system. The idea is to participate in the bull run (momentum) without closing our eyes to drawdown. Return is always risk adjusted, never standalone. 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 is 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, lets just say our selection universe is done systematically following a code, lets say 52 week high. (its a little heavy than that, but still very simple)
However, where we differ is volume and the Earnings factor we attach to our selection, narrowing it down considerably, allowing us a much concentrated portfolio. 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 on the index 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 2011-12 environment (-11%), it would ride the entire 2003-2007 rally, save u from 2008 crash (-28%) and would ride 2014-2017 Modi rally (70% CAGR) without losing our shin in 2016.
** Author pledges his liquid bees to write option spreads, you can of course find higher yielding debt funds.