Timing the Market Using Factors

An AQR Capital Management study suggests that in addition to traditional price momentum, capturing the momentum of characteristic-based factors may boost returns.

The price momentum factor is based on evidence that assets recently experiencing high returns compared to similar securities are more likely to experience high returns in the future. The study looked at a strategy called “factor momentum” that buys stocks with recent top-performing factors based on valuation ratios, profitability metrics and liquidity measures and sells stocks exhibiting poor performance on these factors. The researchers constructed 65 characteristic-based factor portfolios to cover the expanse of factors proposed in the academic literature. Out of the 65 factors, 59 exhibited positive correlation with their own returns over a one-month period.

As each factor represents a portfolio of different stocks, this methodology is broad and diversified so that the performance of one stock is unlikely to have an impact on the overall performance of one portfolio. This could imply that momentum can be exploited to generate excess returns. In addition, factor momentum and price momentum were found to be complementary.

The researchers further posit that conclusions from U.S. samples are strongly corroborated in the international equity markets as well, with individual factors showing high persistence. The researchers conclude that for investors who want to time the market to attempt best pricing, a factor momentum strategy may be an effective addition to a traditional price momentum strategy.

Source: “Factor Momentum Everywhere,” by Tarun Gupta and Bryan Kelly; AQR Capital Management LLC, Greenwich, Connecticut, January 2019.