Momentum ETFs and Talcum powder

First up a definition about what momentum investing is.

Momentum investing involves a strategy to capitalize on the continuance of an existing market trend. It involves going long stocks, futures or market ETFs showing upward-trending prices and short the respective assets with downward-trending prices.

Essentially you buy what has been going up lately and sell what has been going down. Not a bad idea if the things you are buying or selling are in a trend and that these trends persist.

Momentum investing holds that trends can persist for some time, and it ’s possible to profit by staying with a trend until its conclusion, no matter how long that may be. For example, momentum investors that entered the U.S. stock market in 2009 generally enjoyed an uptrend until December 2018.

Indeed you would have done well with this strategy over the last ten years. Now of course, as Wall Street is prone to do they have created a product that lets you tap into this “magic” and charge you a modest fee at the same time. See the MTUM ETF.

So what do the pros think?

Few professional investment managers make use of momentum investing, believing that individual stock picking based on an analysis of discounted cash flows and other fundamental factors tends to produce more predictable results, and is a better means of beating index performance over the long term. “As an investment strategy, it’s a thumb in the eye of the ‘efficient market hypothesis’ (EMH), one of the central tenets of modern finance,” to quote a UCLA Anderson Review article, “Momentum Investing: It Works, But Why?” published on Oct. 31, 2018.

But feelings are mixed.

However, momentum investing has its advocates. In a 1993 study published in the Journal of Finance documented how strategies of buying recent stock winners and selling recent losers generated significantly higher near-term returns than the U.S. market overall from 1965 to 1989, as the Review piece noted.

To create an ETF like this you need some sort of rule about what to buy and when and how to rebalance your portfolio. Here rebalancing means selling stuff that isn’t momentum-y anymore. An interesting question is what is the effect of volatility on momentum strategies?

Apart from an increasing trend one feature of the equity markets over the last ten years has been lower volatility. Apart from a few mishaps that is.

The sustained volatility in December prompted a rebalancing in the holdings of MTUM away from the tech names and into health care and consumer staples. You can see historical information in the Holdings section of this page.

At the time of writing (March 13th) the top six holdings are: 1 Proctor and Gamble, 2 Microsoft, 3 Merck, 4 Johnson and Johnson, 5 Pfizer and 6 Berkshire Hathaway!

Quick someone tell Buffett he’s buying momentum stocks!

With increased volatility PG and JNJ have seen buying as they are defensive stocks with good balance sheets and fairly secure dividends but I wouldn’t count on them to produce the kind of returns that the previous momentum stocks did. If we are in for more regular bursts of increased volatility then momentum strategies like this would get whipsawed and may well underperform.

As an aside Johnson and Johnson recently got fined for its Talcum powder. How can something that smells so nice be so bad for you? Oh wait, the double sausage egg McMuffin? For 500 calories doesn’t sound so bad now does it (alongside carrot sticks of course). But its not all doom and gloom Monsanto paid out loads more and they’re still churning out the genetically modified seeds. Although I think Bayer pulled the short straw.

All we need now is for Boeing to make a killer plane!

As an aside one of my personal favourites is the Global X Uranium ETF (URA)

URA is the only fund on the market that offers targeted exposure to global uranium and nuclear component companies. It holds a highly concentrated, top-heavy portfolio of primarily small- and micro-cap firms. URA steers clear of large mining conglomerates like Rio Tinto and BHP Billiton—these companies account for a large portion of the uranium market, but aren’t pure play. To add liquidity and diversification to the fund, the index provider includes nuclear component companies. URA’s niche exposure comes with a high price tag, but investors with a strong conviction about the future of uranium may be willing to stomach its costs. Realized expenses are tough to predict, however, as the fund’s tracking has been inconsistent.

The returns on this have certainly not been average!

Written on March 14, 2019