Momentum is the best-known anomaly in equities. It says that past winners (losers) will continue to have strong (weak) returns in the future. But does that anomaly also work in mutual funds? Academic research confirms it and shows it could be a good way to pick the future best performing mutual funds.
Several measures of momentum could be used – 1 year high in fund net asset value, simple momentum, or fund sensitivity to momentum factor (momentum load). All three components contain significant, independent information about future fund performance (and have approximately zero correlation); therefore, all of them could be probably used altogether to obtain even greater performance. However, no such combined strategy has been investigated in source paper; therefore, we present the strongest predictor among three – simple price momentum.
Academic research suggests that it seems unlikely that investors are identifying skilled managers, but rather, they are crudely chasing performance. Equity mutual funds usually differ by the style employed by their managers. Therefore mutual fund investors are in reality picking different management styles, and academic research suggests there is strong momentum effect between equity styles (see „Style Rotation Effect“) and momentum effect in market anomalies (see „Momentum effect in anomalies/trading systems“) therefore it appears that this performance chasing has strong fundamental reasons for functionality.
Confidence in anomaly's validity
Backtest period from source paper
Notes to Confidence in Anomaly's Validity
Period of Rebalancing
Notes to Indicative Performance
per annum, annualized (geometrically) 1 month performance 1,46% of top 6-month momentum decile of No-Load funds from table V
Notes to Period of Rebalancing
Number of Traded Instruments
Notes to Estimated Volatility
calculated from t-statistic from table V
Notes to Number of Traded Instruments
Notes to Maximum drawdown
Notes to Complexity Evaluation
Simple trading strategy
The investment universe consists of equity funds from the CRSP Mutual Fund database. This universe is then shrunk to no-load funds (to remove entrance fees). Investors then sort mutual funds based on their past 6-month return and divide them into deciles. The top decile of mutual funds is then picked into an investment portfolio (equally weighted), and funds are held for three months. Other measures of momentum could also be used in sorting (fund’s closeness to 1 year high in NAV and momentum factor loading), and it is highly probable that the combined predictor would have even better results than only the simple 6-month momentum.
Hedge for stocks during bear markets
No - A fund momentum strategy is implemented in a long-only variant, which means that it is not suitable to hedge equity market risk.