Absolute versus Relative Momentum Across Asset Classes

Is the trend your friend?

February 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Absolute and relative momentum can be used as simple asset allocation frameworks
  • Both would have generated a higher return than an equal-weighted portfolio across asset classes
  • However, risk-adjusted returns were lower and drawdowns higher

INTRODUCTION

Investing is often overwhelming given the enormous number of strategies and asset classes that are available to investors. Deciding on how to allocate to equities is already challenging, eg investors need to decide on U.S. versus international and emerging market exposures, sector versus factor-based allocations, active versus passive funds, and so on.

But how about currencies or commodities? Although there are plenty of experts within those markets who offer advice on what to buy, most of these struggle to predict these markets accurately.

A simple way to reduce the complexity of asset allocation is to use a trend following model. This approach essentially abolishes the need for specialist knowledge as it uses the same buying and selling rules for all assets. There are various ways to implement such a momentum-based framework and trend following funds, which are also called managed futures or CTAs, typically pursue this across as many asset classes as possible and take long as well as short positions (read Creating a CTA from Scratch – II and Replicating a CTA via Factor Exposures).

However, we can also create a simpler version by only going long the four major asset classes, namely equities, bonds, currencies, and commodities. We can measure trends on an absolute basis, where we require positive performance, or a relative basis, where we only select the best-performing asset class.

In this research article, we will contrast absolute versus relative momentum across the major asset classes.

ABSOLUTE VERSUS RELATIVE MOMENTUM

We define absolute momentum as a positive total return over the last 12 months, compared to the best performance over the last 12 months for re