Momentum ETFs

Discussion of the Stock portion of the Permanent Portfolio

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jalanlong
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Momentum ETFs

Post by jalanlong » Thu Jul 30, 2020 10:12 am

I have started delving into the new Factor ETFs that are out there. Momentum seems to be an interesting one. For example the S&P LC, MC and SC Momentum ETFs from Invesco (SPMO, XMMO,XSMO) backtested for the past 5 years of their existence very handily beat the basic S&P indexes to which they correspond.

What are some opinions on these funds? Is Momentum something that would be a sustainable factor? In the bloodbath that was March of this year, the the indexes lost 18% whereas the Momentum funds tied to them lost only 13%. The history of the ETFs is short of course.
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Smith1776
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Re: Momentum ETFs

Post by Smith1776 » Thu Jul 30, 2020 2:35 pm

I have money invested in the momentum factor myself. I have lots of factor diversification in the equity portion of my PP. Vanguard makes a good momentum ETF for Canadians (VMO). I'm sure they have similar funds for other countries.

In the academic literature the momentum premium is very well supported. It is persistent through time, it is pervasive through many different asset classes, it works all around the world (except Japan, but value is strong there), and there are some intuitive economic reasons as to why we think it should persist. Momentum is somewhat difficult to reconcile with traditional economic theory regarding efficient markets. However, we think that because there are limits to arbitrage, because markets take time to assimilate new information, and due to under- and overreaction, we think momentum should likely persist even after discovery.

Beyond the behavioural, researchers such as Cliff Asness of AQR capital have posited risk based explanations. He suggests that momentum is strongest among stocks with large growth potential but risky cash flows. The real risk to the investor being that the projected cash flows and growth simply don't actually materialize.

The momentum premium in the literature is large. It's actually larger than market beta. However, of all the well supported factors, momentum has by far the highest turnover and transactions costs. After frictional costs the premium is more modest but still positive. Because it's more modest than the theoretical premium it gives us another reason to believe it should persist into the future because it is not a free lunch/arbitrage. It is simply a plus.

In the end, I think it makes sense to diversify the equity in the PP amongst as many countries and factors as possible.

I like the following split for the PP's 25% equity:

- 12.5% in world market cap index funds
- 12.5% evenly split amongst as many unique factor exposures as possible.
PP + VP + Bank Cash + Physical Bullion
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