Value and Momentum – Underpinning of Our Investment Process
It’s difficult to start an investment firm. The hardest thing is to name it. The second hardest is to initiate an investment process that will stand the test of time.
We were lucky enough to have waited to start KilterHowling until we had years of experience under our belts that informed how our investment process would take shape.
Experiencing market cycles like the tech bubble and the financial crisis are not experiences we want to repeat at KH. We know risk management needs to be part of every client’s portfolio.
We asked ourselves how we could improve upon the simple diversification that most advisors and professional investors use? Drawing on our collective backgrounds, we sought to build portfolios with diversification that endures even during periods of crisis.
Our research over the years as to how best to create this type of portfolio led us to pair value and momentum investing styles. Some of the articles we armed ourselves with:
- “Fact Fiction and Momentum Investing” (Asness, Frazzini, Israel, and Pedersen, May 2014)
- “Value and Momentum Everywhere” (Asness, Moskowitz, and Pedersen, June 2012)
- “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency” (Jegadeesh, Titman, March 1993)
We never want to make our newsletter overly academic, but we think it is useful to understand there is some academic research supporting the benefits of value and momentum investing styles working together. One thing that is clear from this research is that value and momentum strategies are persistent across asset classes and geographies. Moreover, they are uncorrelated and provide the diversification we are looking for.
This makes intuitive sense. It is difficult for value investors to buy winners when they might be expensive from a fundamental point of view. When to sell is the value investor’s great conundrum, and adding a momentum strategy helps balance these problems.
Momentum strategies experience the opposite phenomenon, perhaps nicely evidenced by the current markets. A complimentary value strategy is likely to have a larger than average allocation to cash at the moment, which should cushion a momentum strategy when markets eventually move lower.
In some ways, it is what Charlie Munger taught Warren (see our summer reading article). There is a justifiable premium to be paid for a quality business, and it is sometimes hard for deep value investors to latch on to this. Warren might not have bought Coca-Cola had it not been for this complementary thinking.
And we might not have written this article if it were not for Quantitative Momentum by Gray and Vogel. Another part of our summer reading list, this book updated the same data used in the article “Value and Momentum Everywhere”. In that article, the authors argue that combining these strategies, especially in a global context, should lead to better risk adjusted outcomes and lower drawdowns. While each strategy on its own might go through periods of under performance, combining them can provide investors with an outcome that is easier to stick with through market downturns.
In many ways this is a page from the hedge fund world, wherein investors diversify by investment style and not just geography or market capitalization. Say what you want about hedge funds but at least they talk about risk in a quantifiable way.
In designing our portfolio process, we aimed to take the best of sophisticated, institutional investment processes and combine that with the best of traditional wealth management. That means low fees, liquidity, risk management, transparency, a fiduciary obligation and investing alongside our clients!
These are the tenets of KilterHowling as a firm. We implement our own versions of value and momentum strategies. After more than three years, we think we are on the right path, and we hope you agree.