01 Jun Learning From Gary Antonacci's "Absolute Momentum: A Simple Rule-Based Strategy and Universal Trend-Following Overlay"

Absolute Momentum asset allocation approach improves risk-adjusted returns and significantly reduces drawdowns.

In this article, Absolute Momentum will be used interchangeably with trend following or time series momentum. Relative Momentum will be used interchangeably with cross-sectional momentum or relative strength.

We can apply absolute momentum to any asset or portfolio of assets without losing any of the contributory value of other assets. With relative strength momentum, on the other hand, we exclude or reduce the influence of some assets from the active portfolio. This can diminish the benefits that come from multi-asset diversification and lead to opportunity loss by excluding lagging assets that may suddenly start outperforming. The second advantage of absolute momentum is its superior ability to reduce downside volatility by identifying regime change.

The paper applied Absolute Momentum on a variety of asset classes and “Table 2” of the paper (reproduced below) shows the performance.

Every asset has a higher Sharpe ratio, lower maximum drawdown, and higher percentage of profitable months with 12-absolute momentum over this 38-year period.

Source: Gary Antonacci

The paper then applied Absolute Momentum on a traditional 60/40 balanced fund and “Table 4” of the paper (reproduced below) shows the performance.

The 60/40 portfolio without momentum shows some reduction in volatility and drawdown compared to an investment solely in US stocks. However, the strong 0.92 monthly correlation of the 60/40 portfolio with the S&P 500 shows that the 60/40 portfolio has retained most of the market risk of stocks. Because stocks are much more volatile than bonds, stock market movement dominates the risk in a 60/40 portfolio. From a risk perspective, the regular 60/40 portfolio is, in fact, mostly an equity portfolio, since stock market variation explains most of the variation in performance of the 60/40 portfolio.

The MSCI US index with the addition of absolute momentum has a 0.74 correlation to the S&P 500, which is lower than the 0.92 correlation of the 60/40 index to the S&P 500. MSCI US with absolute momentum does a better job than the 60/40 portfolio in reducing portfolio drawdown, while also providing higher returns. The correlation to the S&P 500 of the 60/40 portfolio using 12-month absolute momentum drops to 0.67 from 0.92.6 The 60/40 portfolio with absolute momentum retains the same return as the normal MSCI US Index, but with only half the volatility. The maximum drawdown drops by more than 70%.

Source: Gary Antonacci

The paper also applied Absolute Momentum on a normal risk parity fund and “Table 6” of the paper (reproduced below) shows the performance.

Parity with 12-month absolute momentum, as presented here, is more adaptive than normal risk parity and has the ability to exit fixed income investments during periods of rising interest rates due to its trend following nature.

Source: Gary Antonacci

Research Paper: Absolute Momentum: A Simple Rule-Based Strategy and Universal Trend-Following Overlay

Authors: Gary Antonacci

Company: Portfolio Management Consultants