Momentum has been found to exist oil all asset classes, yet there are risks with this core strategy. Momentum portfolios may be subject to crashes - sudden declines in return which makes holding momentum portfolios risky. See "Momentum Crashes".
In a state of panic or during periods of high volatility, the prices of past losers will have a high premium. When the markets conditions change and there is a rebound, losers will see strong gains which will lead a crash for those assets that are held short. Down market betas of past losers re low and the up markets betas are very high. This type of optionality may not be priced in the past losers. Given these conditions the past losers now have high expected returns which is what an investor does not want to hold. Unfortunately, this behavior does not apply to the winners during good times. Hence there is an asymmetry in the exposure of winners and losers during extreme times.
Given this pattern is predictable, it can lead investors to dynamically adjust their exposures during these periods to adjust the loser's portfolio and avoid these sharp reversals. It is notable that the crash risk story seems to serve as a good story for equities but is harder to apply to other asset classes such as bonds, currencies, and commodities.
The presence of crashes with momentum is a good reason to manage downside with stop-losses and to manage volatility exposure. Momentum may not be a factor that follow set-it and forget-it strategy.
No comments:
Post a Comment