Momentum Effect in Country Equity Indexes

The momentum anomaly is one of the strongest anomalies which are academically described. It was originally discovered in stocks in just one country, but more and more academic studies shows it is working also on country equity indexes, and it’s performance shows strong persistence.

Fundamental reason

Academic studies shows strong support for momentum effects. The main reasons for anomaly persistence are behavioral biases like investor herding, investor over and underreaction and confirmation bias.

Markets traded
Confidence in anomaly's validity
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Period of rebalancing
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Number of traded instruments
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Complexity evaluation
Simple strategy
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Financial instruments
ETFs, funds
Backtest period from source paper
Indicative performance
Notes to Indicative performance
per annum, performance depends on chosen lookback and holding periods, data from Figure 13
Estimated volatility
not stated
Notes to Estimated volatility
Maximum drawdown
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Notes to Maximum drawdown
Sharpe Ratio
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momentum, rotational system, country picking

Simple trading strategy

The investment universe consists of ETFs (funds) which invest in individual countries equity indexes. The top 5 countries with the best X - month (where X depends on investors choice, studies shows X to be best as 10-12) momentum are chosen as investment and portfolio is rebalanced once in a month.

Source Paper

Muller, Ward: Momentum effects in country equity indexes
This paper examines the 70 country indices which comprise the MSCI world index as a representative set of global equity investment opportunities, and examines momentum and mean reversion effects in these. We show that persistent and significant effects do exist, particularly with regard to short-term momentum. A strategy of holding for one month, a portfolio of the four best performing MSCI country indices over the previous 11 months, was found to persistently out-perform an equal weighted benchmark by around 10% per annum over the 39 year period from 1970 to 2009.

Other Papers

Bhorjaj, Swaminathan: Macromomentum: Evidence of Predictability in International Equity Markets
This study examines momentum and reversals in portfolios of international stock indices. The results indicate strong momentum up to a year following the portfolio formation date and significant reversals in the subsequent two years. While momentum is driven mostly by predictability within equity markets, reversals are at least partly due to a continuing decline in stock prices in response to past currency appreciation. These patterns seem to be related to misreaction to news about macroeconomic conditions, not corporate earnings. Overall, our results demonstrate the pervasiveness of momentum and reversals and provide support for behavioral theories.

Balvers, Wu: Momentum and mean reversion across national equity markets
Numerous studies have separately identified mean reversion and momentum. This paper considers these effects jointly. Our empirical model assumes that only global equity price index shocks can have permanent components. This is motivated in a production-based asset pricing context, given that production levels converge across developed countries. Combination momentum-contrarian strategies, used to select from among 18 developed equity markets at a monthly frequency, outperform both pure momentum and pure contrarian strategies. The results continue to hold after corrections for factor sensitivities and transaction costs. They reveal the importance of controlling for mean reversion in exploiting momentum and vice versa.

Andreu, Swinkels, Tjong-A-Tjoe: Can exchange traded funds be used to exploit country and industry momentum?
There is overwhelming empirical evidence on the existence of country and industry momentum effects. This line of research suggests that investors who buy countries and industries with relatively high past returns and sell countries and industries with relatively low past returns will earn positive risk-adjusted returns. These studies focus on country and industry indexes that cannot be traded directly by investors. This warrants the question whether country and industry momentum effects can really be exploited by investors or are illusionary in nature. We analyze the profitability of country and industry momentum strategies using actual price data on Exchange Traded Funds. We find that, over the sample periods that these ETFs were traded, an investor would have been able to exploit country and industry momentum strategies with an excess return of about 5% per annum. The daily average bid-ask spreads on ETFs are substantially below the implied break-even transaction costs levels. Hence, we conclude that investors that are not willing or able to trade individual stocks are able to use ETFs to benefit from momentum effects in country and industry portfolios.

This paper empirically investigates whether momentum strategies applied to past returns of national stock indices generate profits. Emphasis is placed in emerging capital markets of Africa, Asia, Europe, Latin America, and the Middle East. We find that the extra returns from momentum strategies are larger for emerging markets than for developed markets. We also find that momentum profits are higher in the pre-market liberalization period than in the post- liberalization period. We postulate that the higher momentum profits generated by emerging markets are due to market isolation and that market liberalization reforms introduced in these countries tend to reduce the profits from momentum strategies.

Zaremba: Country Selection Strategies Based on Value, Size and Momentum
This study provides convincing evidence that stock markets with low capitalisation, low valuation ratios and good past performance ten to outperform country markets with high capitalisation, high valuation ratios and low momentum. Based on sorting procedures and cross-sectional tests conducted across 78 countries over the period 1999 to 2014, it has been found out that value, size and momentum effects at the country level are stronger across small and medium country markets than large ones. Thus, bearing in mind the declining benefits of international diversification observed in recent decades, it is recommended that investors include country-level factor premiums in their strategic asset allocation, without postponing them to further stages of an investment process. In addition, it has been shown that intermarket value, size and momentum effects may be used in multifactor asset pricing models, which perfectly explains the variation in stock returns at the country level.

Grobys: Another Look at Momentum Crashes
This paper studies the profitability of a selection of prominent momentum-based strategies in the European Monetary Union. In contrast to past examples documenting the lack of profitability of unconditional price momentum in the most recent decade, the current research finds that unconditional price momentum based on intermediate past performance, as proposed in Novy-Marx (2012), yielded significantly positive payoffs. While profitability is driven by the short side of the strategy, there is no evidence of any option-like behavior. Surprisingly, the momentum strategy based on intermediate past performance generated normally distributed payoffs.

Geczy, Samonov: 215 Years of Global Multi-Asset Momentum: 1800-2014 (Equities, Sectors, Currencies, Bonds, Commodities and Stocks)
Extending price return momentum tests to the longest available histories of global financial asset returns, including country-specific sectors and stocks, fixed income, currencies, and commodities, as well as U.S. stocks, we create a 215-year history of multi-asset momentum, and we confirm the significance of the momentum premium inside and across asset classes. Consistent with stock-level results, we document a large variation of momentum portfolio betas, conditional on the direction and duration of the return of the asset class in which the momentum portfolio is built. A significant recent rise in pair-wise momentum portfolio correlations suggests features of the data important for empiricists, theoreticians and practitioners alike.

Zaremba: Combining Equity Country Selection Strategies
The recent rise of passive investment products granted investors easy access to international markets. The basic motivations of this paper is to offer investors new tools to allocate assets across countries. The study investigates the performance of equity country selection strategies based on combinations of theoretically and empirically motivated variables. Thus, we form portfolios and assess their performance with asset pricing models. The empirical examination is based on data from 78 within the period from 1999 to 2015. The strategies based on earnings-to-price ratio, turnover ratio and skewness prove useful tools for international investors. Furthermore, portfolios from sorts on blended rankings of skewness combined with earnings-to-price ratio or turnover ratio are also characterized by attractive risk-return relation. However, the joint strategies do not outperform the strategies based on single metrics. As a result, we argue that given the low correlations among the returns on single-variable strategies investors would be better off building a diversified portfolio of them than combining them into one strategy.

Guilmin: The Effective Combination of Risk-Based Strategies with Momentum and Trend Following
The Efficient Market Hypothesis (EMH) has been widely called into question in the investment literature, through two main anomalies: timing and low-volatility anomalies. In this paper, we aim to combine the predictive power of timing and low-volatility strategies to deliver better risk-adjusted portfolio performance. We adopt a two-step approach for a constant dataset composed of 18 country MSCI stock market indices over the 1975-2014 period. First, we use different timing strategies: moving averages and momentum. We select stock market indices based on different moving averages (6, 8, 10, and 12 months), while the momentum strategy ranks the different stock market indices into momentum subsets (low, medium, and high momentum). After the first step using the different timing strategies, the second step consists in building risk-based portfolios (MV, ERC, and MD) as well as 1/N benchmark portfolios for each of these timing strategies. Our results highlight the effectiveness, the relevance and the robustness of our approach. First, risk-based portfolios using relevant timing strategy indeed provide better returns, lower volatilities, higher Sharpe ratios, and lower Value-at-Risk (VaR) and Expected Shortfall (ES) than traditional risk-based portfolios. The second contribution of our approach features that risk-based strategies provide better risk-adjusted returns and lower VaR and ES than the 1/N portfolio within a context in which the first step is dedicated to the application of a relevant timing strategy. Finally, among these risk-based portfolios using relevant timing strategies, the MD and MV portfolios usually obtain the best risk-adjusted performance.

Dobrynskaya: Upside and Downside Risks in Momentum Returns
Abstract: I provide a novel risk-based explanation for the profitability of momentum strategies. I show that the past winners and the past losers are differently exposed to the upside and downside market risks. Winners systematically have higher relative downside market betas and lower relative upside market betas than losers. As a result, the winner-minus-loser momentum portfolios are exposed to extra downside market risk, but hedge against the upside market risk. Such asymmetry in the upside and downside risks is a mechanical consequence of rebalancing momentum portfolios. But it is unattractive for an investor because both positive relative downside betas and negative relative upside betas carry positive risk premiums according to the Downside-Risk CAPM. Hence, the high returns to momentum strategies are a mere compensation for their upside and downside risks. The Downside Risk-CAPM is a robust unifying explanation of returns to momentum portfolios, constructed for different geographical and asset markets, and it outperforms alternative multi-factor models.