Value, Momentum & Carry Across Asset Classes

Farming is a Profession of Hope (Brian Brett). Investing, too.

January 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Cross-asset multi-factor exposure might be an attractive diversifier for an equity portfolio
  • Factors share trends across asset classes, indicating common drivers
  • However, relationships are time-varying, increasing complexity and risks

INTRODUCTION

There is a 72% probability of the San Franciso Bay Area getting hit by at least one earthquake of a magnitude of 6.7 or stronger between today and 2043 according to the United States Geological Survey, which is a scientific agency of the U.S. government. An earthquake of that magnitude is likely to cause major damage in populated areas, especially if accompanied by a tsunami.

Given high valuations, record levels of debt, and poor demographics investors are likely to get hit by financial earthquakes with almost a 100% probability before 2043. The two core approaches for minimizing financial damage are hedging strategies and portfolio diversification, or a combination of both.

Long-short factor investing strategies are typically structured beta-neutral, which would provide diversification for a classic equity-bond portfolio. Academic research supports that factor returns can be harvested from equities as well as from other asset classes, where they are usually called risk or style premia. Institutional investors have bought more than $500 billion in risk premia products from investment banks, highlighting the interest in uncorrelated strategies that may preserve capital.

In this short research note we will investigate Value, Momentum and Carry factors across asset classes as well as the benefit of adding an allocation of these to a classic equity-bond portfolio.

METHODOLOGY

Equity factor performance is derived from beta-neutral long-short portfolios comprising the top and bottom 10% of stocks. Portfolios are created on a country level and then aggregated to a global portfolio by weighting allocations by market capitalization. Only stocks with market capitalizations larger than $1 billion are included. Portfolios are rebalanced monthly and each transaction incurs costs of 10 basis points.

Currency, commodity and fixed income factor data is sourced from HFRX, which aggre