16/03/2023 - 16/03/2023
Systematic Long-Only Momentum Strategy in Financial Markets: Evidence from India
A career banker with over 25 years of experience spread out across US, Europe and Asian markets, Prof. Rajan Raju heads Invespar Pte Ltd., as Director and is also Visiting Faculty at IIMA. Harish Krishnan has close to two decades of experience spread over Equity Research and Fund Management. Since 2013, Krishnan has been managing various equity schemes as a Senior Fund Manager at Kotak Mutual Fund. A Long Only India Specialist, Krishan is the Senior Fund Manager at Kotak Mutual Fund. Prof. Arvind Sahay is a Professor of Marketing & International Business and the Chairperson of the NSE Centre for Behavioral Science at IIMA. Prof. Sahay is also the author of, ‘Brands & the Brain’ published by Penguin Random House in 2022.
Factors are investment styles that deliver relatively higher returns over the long run. These risk premiums don’t come for free, as factors can (and will) underperform in the short (or even medium) run. Static factors like equities and bonds whose risk premiums are obtained by simply buying assets (long-only positions). Dynamic factors involve long-only or long-short portfolios where portfolio weights are constantly/regularly adjusted. The superior returns to factors, on average, arise as they underperform during bad times, sometimes dramatically. For most investors, bad times matter more than good times: understanding the factor risks of a portfolio is essential.
Factors originate primarily from academia, motivated by economic and behavioural theory and empirical study. They extend CAPM and attempt to explain the average returns of portfolios. A systematic tilting toward a style that is implemented across a diversified set of assets include tilts that deviate from market weights and long-only or long–short portfolios. Discretionary or active management using factors is common, explicitly or implicitly. Active or systematic, rule-based factor strategies use the same ideas and are subject to common misconceptions.
Winner stocks continue to win, and losers continue to lose. Momentum is the strategy of buying stocks that have gone up over the past 12 months (winners) and shorting stocks with the lowest returns over the same period (losers). It is a cross-sectional strategy. Winners and losers are always relative, and the market as a whole can go up or down. It is well-established empirical factor whose premium is evident over time, markets and asset classes.
In practice, there are more dimensions to constructing efficient portfolios than simply accepting market risk (a factor in itself!). They are not arbitrage opportunities. In the long term, factors provide excess returns beyond market risks because they compensate for additional risk exposure in an efficient market, which is important to some investors (the rational explanation) and/or are based on behavioral biases of investors (the behavioral explanation), and/or they exploit the “other side” of different preferences or beliefs of some investors (the other side).
Like the international evidence, in India, the momentum factor earns higher returns over the long run because it suffers bad times in the short (momentum crash) or even medium term. Not all implementations are the same. Implementation risks include liquidity, capacity, slippage, and turnover. The Indian market is top-heavy, which poses unique challenges for investment managers. Asset owners and wealth managers should understand how these risks are managed. There is an opportunity for craftsmanship alpha. Rather than relying on opinion, evidence should be used. Academic factors can help understand the drivers of return. It is also important to understand factor risks.