Consistent Profits Using Value and Momentum?

“Let Them Eat Cake”, or as Queen Marie Antoinette would have famously said, “Qu’ils mangent de la brioche” in her native tongue during the time of famine and revolution in France hundreds of years ago. While there’s no evidence or record that the statement was ever actually said, the famed line sticks with us to this day. But it’s not the only common phrase we use when referring to cake that most remember.

At some point, I’d bet someone with a harsh gaze turned to you and said, “You can’t have your cake and eat it too”. And I’m guessing that didn’t settle well with you either. According to the proverb’s meaning, we are supposed to come away with the understanding that one cannot have it both ways… or that we shouldn’t have more than we actually deserve. Rubbish…

It’s the latter meaning which often bothers me when trying to understand why investors continually stick to the same strategy regardless of how inconsistent it might be. For example, many self-proclaimed experts believe you have to be in one investment camp or the other, fundamentals or technicals. They tend to lean one way and completely slam the door on any alternative approach to securing consistent profits.

With that said, a recent study came across my desk which explored a common dilemma we investors face. Cast our lot with undervalued stocks or ride the wave of momentum and place faith in the trend?

Focusing solely on value or momentum has proven to be a highly volatile venture over the past 50 years. If you didn’t know when to cash out you got burned. Each strategy worked well for a few years until it fell on its face – right when proponents thought they had it all figured out. And that’s why strategies that seem too simple or too complicated leave many stuck, wondering if there’s a more reliable approach that doesn’t involve taking high blood pressure medication.

But what if we could have our cake and eat it too?

The same researchers who discovered the flaws of a pure momentum portfolio versus that of value also wisely explored performance when those allocation ratios were adjusted away from the extremes. 10 percentage point tweaks were made giving us an entire spectrum of backtested results.

Here’s what study conducted by Millennial Invest found…

Portfolio Allocation value and momentum 300x125 - Consistent Profits Using Value and Momentum?Chart by Millenial Invest

From the chart above, one should arrive at the conclusion that a portfolio allocation consisting of 70% value and 30% momentum yielded the highest return when risk and volatility were factored in.

So this would suggest that over a long period of time, a fundamental value focus can hold significant importance in the investment decision making process. And we can actually amplify profits while at the same time reducing our risk exposure by actively seeking to establish positions in equities with momentum that are appreciating despite the existence of difficult market conditions.

While the study above highlights the advantages of merging value and momentum, it’s often easier said than done in practice. Let’s face it, most investors never majored in finance, studied charts or went on to establish a career in the industry.

If you fall into that mold and are a long-term investor looking to benefit from the strategy without the hassles of research and management then we’d suggest looking into ETFs that focus on each camp and then combining them into a portfolio.

On the value side, you could invest 70% of your capital into the iShares Russell 1000 Value ETF (IWD) or perhaps a Vanguard Russell 1000 Value Index (VONV). Then, move the remaining 30% of your funds into the Russell 1000 High Momentum ETF (HMTM) or Russell 2000 High Momentum ETF (SHMO).

With a bulk of your investment dollar in value, let’s explore our options in greater detail. VONV currently trades at a slight discount compared to IWD. However, IWD provides a high degree of liquidity with an average daily volume of 3.0 million which happens to be substantially higher than VONV’s average daily volume of only 39,694. While most of the ETF statistics above are quite similar there is something to be said about the value of liquidity and having the option to reduce equity exposure in the event you must pull out of the market at a respectable price for any number of various reasons.

Both have performed better than their benchmarks over time with VONV being the better bet in the annual return department. Unfortunately, VONV has yet to be tested during a major market downturn, so it’s a bit difficult to say which one would have outperformed during the recent 2008 pullback.

Finally, the last step is to simply monitor your allocations as dollar amounts invested in the ETFs mentioned above fluctuate over time with the performance of the funds.

Good investing,
Reflex Investor

P.S. Check out our comprehensive financial newsletter, Reflex Momentum Report. It uncovers “under the radar” investment opportunities, marrying fundamental quality with critically important technical timing to enhance potential returns.

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