Value and momentum: two completely different animals

CIO Insights 2Q2017

When academics theoretically backward test return figures on investment style, they usually reach the conclusion that “momentum” and “value” work best. From a practical perspective, however, the two could not be more different. We would like to point out some of the reasons why this is the case and what the implications for investors are.

Momentum basically stipulates that equities exhibiting recent up or down moves in price will continue along the same path for some time to come. Essentially it is a pure trend-following concept akin to technical analysis, perhaps with some economic analysis mixed in. A big share of the money management business is based either implicitly or explicitly on momentum ideas: these days it is the “FANGs” and “BATs” (dominating tech and social media companies); during the mid -2000s it was the “BRICs” (select emerging markets rich in natural resources whose prices were deemed to be in a “super-cycle”); at the end of the 1990s, there were the “TMTs” (exciting industry sectors riding the emerging internet wave); in the late 1960s, the “Nifty-Fifty” (far-flung conglomerates growing by means of financial engineering) were all the rage; and so on down history.

Value, on the other hand, cannot be that neatly categorized. It involves a conservative fundamental assessment of the net worth of specific firms. The chief goal is to identify mispriced equities, each evaluated and valued on a case-by-case basis. Every analyst works independently on his unique set of investment projects. Unlike momentum, value strictly revolves around tangible corporate considerations rather than uncontrollable stock price swings. Consequently, there are no catchy names, acronyms and fashionable trends. Long-only value, by definition targeting underappreciated equities, emerges in uneven intervals given the particular company’s state of betterment. On a portfolio level, then, value realization occurs randomly over time, regardless of overall stock market conditions.

Consequently, crucial distinctions exist in terms of how the two strategies need to be handled in order to deliver fruitful results. For one, momentum may work only for traders, speculators or gamblers, but not for buy-and hold investors. Simply put, momentum works until it stops working. As such, momentum is not a strategy capable of naturally compounding total return over time. The trader will always depend on the next great idea once momentum in the last position fades, cedes or even reverses. These characteristics induce timing risk in that the trader must always take a view based on popularity, or expected crowd behavior; a tricky undertaking given that mass psychology regularly causes market participants to bet on initially promising but ultimately failing trends.

In contrast, value is appropriate for patient long-term investors and savers only. It requires perseverance and operates in a timeless compounding context. That is, total return accrues over time in a slow, grinding, lumpy and unpredictable fashion. As a quintessentially contrarian approach, value tries to take advantage of irrational mass psychology instead of incurring the risk of falling prey to it.

To sum up, in practice momentum clearly is a transactional product which may be implemented through fintech-type automated tools or quantitative solutions as well as through ETFs and other passive vehicles. A momentum player is constantly forced to decide whether to buy or to sell. Value, on the other hand, embodies an enduring and hence relationship-driven buy-and-hold investment philosophy. It is entirely knowledge-based and therefore people-dependent. Thus it can only be effectively implemented by means of a fund or a separate mandate structure.

Momentum is not part of our skill-set; we gladly leave that field to other people who may be better at it. It is value that we live and breathe. And we strive, on a continuing basis, to achieve an attractive long-term outcome for the benefit of our loyal clientele.

Sincerely,