Momentum Factor and Style Rotation Effect

Academics have shown that momentum strategies are able to generate extraordinary excess returns in virtually every asset class (stocks, FX, commodities) or their respective parts (equity sectors, industries, countries). This includes momentum into the standard strategy set of nearly each portfolio manager. But is momentum applicable also to market anomalies or factor portfolios? Yes, it is. Multiple research papers show it is possible to apply momentum strategies to successfully rotate between equity styles (small cap value, large cap growth etc.). The beauty of this approach is its simplicity (as various equity styles portfolios are easily accessible via ETFs) and the practically zero correlation to broad equity market (if the investor uses the long-short version of this strategy) which makes this it an easily accessible, good portfolio diversifier.

Fundamental reason

The obvious observation is that styles perform differently over time (the same way different assets do). The popularity of style investing itself may influence the structure and dynamics of asset returns since prices deviate substantially from fundamental values as styles become popular or unpopular. This non-random behavior gives foundation to rise of exploitable momentum.

Markets traded
Confidence in anomaly's validity
Notes to Confidence in anomaly's validity
Period of rebalancing
Notes to Period of rebalancing
Number of traded instruments
Notes to Number of traded instruments
Complexity evaluation
Simple strategy
Notes to Complexity evaluation
Financial instruments
Backtest period from source paper
Indicative performance
Notes to Indicative performance
per annum, long short strategy, data from table 3
Estimated volatility
Notes to Estimated volatility
long short strategy, data from table 3
Maximum drawdown
not stated
Notes to Maximum drawdown
Sharpe Ratio


style picking, rotational system, momentum

Simple trading strategy

Russell’s ETFs for 6 equity styles are used (small cap value, mid cap value, large cap value, small cap growth, mid cap growth, large cap growth). Each month, the investor calculates 12 month momentum for each style and goes long on the winner and short on the loser. The portfolio is rebalanced each month.

Hedge for stocks during bear markets

Not known - Source and related research papers don't offer insight into correlation structure of proposed trading strategy to equity market risk, therefore we do not know if this strategy can be used as a hedge/diversification during time of market crisis. Strategy is built as a long-short, but it can be split into 2 parts. Long leg of strategy is surely strongly correlated to equity market however short-only leg can be maybe used as a hedge during bad times. Rigorous backtest is however needed to determine return/risk characteristics and correlation.

Source Paper

Tibbs, Eakins, DeShurko: Using Style Index Momentum to Generate Alpha
Russell style indexes exhibit significant momentum, particularly after medium term out- and underperformance. The existence of this momentum produces a diversified, index-based low-cost means to exploit momentum by incorporating relative style index performance into tactical allocation strategies. Such style index momentum trading strategies have outperformed on both a raw and risk- adjusted return basis, with the long minus short portfolio generating an average 9.25% annual return over the 34-year period analyzed. Although the excess returns vary, they are robust through time and after controlling for potentially confounding effects. Additionally, the returns are not driven by any single style index and portfolio reconstruction is, on average, required every six months.

Hypothetical future performance

Strategy's implementation in QuantConnect's framework (chart+statistics+code)

Other Papers

Chen, DeBondt: Style momentum within the S&P-500 index
Investors may be able to benefit from equity style management. We find that three company characteristics—market value of equity, book-to-market ratio, and dividend yield-capture style related trends in equity returns. We study all firms in the Standard and Poor’s-500 index since 1976. Strategies that buy stocks with characteristics that are currently in favor (past winners) and that sell stocks with characteristics that are out-of-favor (past losers) perform well for periods up to 1 year and possibly longer. Style momentum in equity returns is an empirical phenomenon that is distinct from price and industry momentum.

Gokani, Todorovic: Profitability of Quantitative vs. Momentum Size and Style Rotation Strategies in the UK Equity Market
This paper examines whether short-term variation in the spreads of the UK size and value/growth style indices is better predictable and exploitable by means of quantitative or momentum style rotation strategy. Applying different long-only and long-short strategies, we find that the value/growth rotation is not profitable regardless of the method used for choosing a style. Alternatively, both quantitative and momentum based small/large rotation is profitable at easily feasible levels of transaction costs for both ETFs and institutional traders, with quantitative rotation having an edge over the momentum one, in terms of generated end of period wealth and Sharpe ratios.

Arshanapalli, Switzer, Panju: Equity-style timing: A multi-style rotation model for the Russell large-cap and small-cap growth and value style indexes
Researchers and practitioners have devoted considerable attention to devising market-timing strategies as potential value-enhancement tools. The success of such active or tactical asset allocation strategies is dependent on their ability to capture either inefficiencies, to the extent that they exist, or disequilibria associated with changes in the investor opportunity set. Much of the equity-style timing literature focuses on the shifting between pairs of risky assets or between one risky and one riskless asset class, using a binomial approach. This paper develops a multinomial timing model based on macroeconomic and fundamental public information using Frank Russell large-cap and small-cap style indexes. We model four different market segments simultaneously. Out-of-sample tests demonstrate that active multi-style rotation strategies can be devised that outperform the best performing buy-and-hold portfolio. The profitability of such strategies is robust to reasonable levels of transaction costs.

Chen, Jiang, Zhu:
Existing literature documents that cross-sectional stock returns exhibit price and earnings momentum patterns. The implementation of such strategies, however, is costly due to the large number of stocks involved and some studies show that momentum profits do not survive transaction costs. In this paper, we examine whether style and sector indexes commonly used in financial industry also have momentum patterns. Our results show that both style and sector indexes exhibit price momentum, and sector indexes also exhibit earnings momentum. Mostly importantly, these momentum strategies are profitable even after adjusting for potential transaction costs. Moreover, we show that price momentum in style indexes is driven by individual stock return momentum, whereas price momentum in sector indexes is driven by earnings momentum. Finally, using style indexes as illustration we show that performance of style investment can be substantially enhanced by incorporating the momentum effect.

Wang, Brooks: Growth/Value, Market-Cap, and Momentum
This paper examines the profitability of style momentum strategies on portfolios based on firm growth/value characteristics and market capitalization. We use monthly total returns of nine S&P style indices to avoid concerns about firm size, liquidity, credit risk, short-sale constraints, and transaction costs. We find that historically buying a past best performing style index and short-selling a past worst performing style index generates economically and statistically significant profit of 0.8% per month over the period June 1995 to March 2009. This profitability remains economically plausible after adjusting for systematic risk, short-sale costs, and transaction costs. Investors may actually implement style momentum strategies on exchange traded funds linked to the S&P style indices.

Liu, Wang: Do Style Momentum Strategies Produce Abnormal Returns: Evidence from Index Investing
In this study, we investigate the return enhancement ability of style momentum strategy: a strategy that switches between value and growth styles based on previous performance. We explore the variation in abnormal returns of long-only and long-short momentum strategies using various style based indexes (Russell value/growth indexes, Fama-French value/growth indexes, and MSCI value/growth indexes) where value and growth stocks are classified using different criteria. Our results show that the performance of style momentum does vary across different index families. We first find that in general the long-only strategies create significant positive abnormal returns whereas the long-short strategies do not. Second, for a fixed formation period, abnormal returns of the strategies tend to decrease when the length of holding periods increase. Third, abnormal returns are stronger and more significant when rotating within large cap value and growth indexes while abnormal returns are weaker and inconsistent when rotating within small cap value and growth indexes. Fourth, strategies based on rotating across all market cap levels do not generate consistently significant positive abnormal returns for Russell indexes or Fama-French indexes but they do for MSCI indexes. Fifth, individual stock momentum only explains a very small portion of the returns of style moment strategies