Sunday, October 25, 2015
Momentum trading Treasuries - it works!
There has been significant research on momentum strategies across all major asset classes; however, the amount of effort used to investigate the efficacy of momentum strategies in fixed income has been limited. This limitation has changed with the work by J Benson Durham, Can Long-only Investors Use Momentum to Beat the US Treasury Market?". Durham shows that long-only fixed income momentum strategies can provided excess returns and good information ratios through forming duration-neutral portfolios along the Treasury yield curve.
Breaking up the yield curve into buckets and determining what combination of bucket to hold based on momentum while still keeping the duration the same as a long-only portfolio of Treasuries is an effective means of control for directional risk. This momentum is robust across a wide number of specifications. The author then compares the excess returns against other factors such a term structure changes to see if there are variables that can explain these excess returns from momentum. The answer found is that momentum cannot be explained by other factors.
Investors who use momentum across different maturity buckets will be rewarded versus just holding the market basket of Treasuries. Futures traders have known this for some time. Once yield markets start to move in a specific direction they will usually continue in that direction. Additionally, there is value in trading different maturities. Different maturities do not all trade the same and a basket of momentum trades will add value. These same results also occur in the UK bond market but not carry-over to the Japanese bond market.
This work just adds to our knowledge that momentum is a risk factor that cuts across all asset classes and careful research that tries to correlate momentum with other economic risk factors will usually come up empty-handed.