MTUM: The Curious Case Of The Largest Momentum ETF – iShares Edge MSCI USA Momentum Issue ETF (NYSE:MTUM)

On the finish of January, the iShares Edge MSCI USA Momentum Issue ETF (MTUM) performed an ad-hoc rebalancing. The index threw out greater beta development shares and obtained defensive. A mixed 36% weight between Tech and the fund’s allocation to prime holding Amazon (AMZN) was chopped in half. Shopper staples expanded from eight% to 13%. Utilities and REITs grew to a mixed 9% from simply over 1%. As an proprietor of the fund, and a believer within the structural alpha supplied by momentum, I used to be somewhat confused by the ad-hoc rebalancing. Over the subsequent few months, the broad inventory market rally gained steam and the rebalancing started to look ill-timed versus the broad market as defensive shares started to lag, inflicting the reconstituted momentum technique to underperform.

MTUM vs SPY after January rebalanceSupply: Bloomberg

Quick ahead one other month, and the rebalancing appears prescient. The wager on decrease volatility shares has paid off. Whereas the broad S&P 500 – and tech particularly – has been waylaid by current commerce tensions, the S&P 500 Low Volatility Index (SPLV) has been hitting all-time highs. The defensive ad-hoc rebalancing of the momentum index has helped that technique outperform as effectively.

MTUM vs SPY since rebalancing Supply: Bloomberg

I’m a believer within the structural alpha generated by momentum. I’ve written ceaselessly on In search of Alpha in regards to the alpha-generative nature of momentum methods. Momentum methods have been demonstrated to provide short-run alpha throughout asset courses, geographies, and time. The canonical momentum technique was first authored by Jegadeesh and Titman (1993), which confirmed that shares that had carried out the most effective (worst) over trailing three- to twelve-month durations continued to carry out the most effective (worst) over ahead three- to twelve-month durations. This analysis is referenced prominently on the iShares web site for this ETF.

Constructing on this educational analysis, I’ve demonstrated on In search of Alpha that extra returns will be generated from momentum methods between home shares and Treasuries, home shares and company bonds, home shares and rising market shares, between various scores cohorts inside company bonds, worth and development shares, low volatility and excessive beta shares, and a number of different imperfectly correlated asset courses, usually using one- to three-month look-back durations and one- to three-month ahead holding durations. If you wish to check whether or not an element works, check it throughout asset courses, geographies, and time horizons. The structural alpha from momentum has proved sturdy. Alpha generative momentum is so pervasive that at occasions I apprehensive that I used to be authoring too many articles on the subject for my readership on the expense of time spent on different evaluation.

After I started to periodically publish my five-factor tilts (measurement, worth, low volatility, dividend development, equal-weighting) which have outperformed the market, I eschewed momentum. Within the kickoff to that sequence, I famous that funding charges amongst households had been falling regardless of decrease boundaries to entry for investing. I wished to explain easy buy-and-hold methods obtainable by means of low-cost exchange-traded funds that captured structural alpha to generate long-run efficiency. My momentum methods tended to contain energetic turnover, given their quick ahead holding durations, which might be unsuitable for taxable accounts and fewer skilled traders.

Just like the ETFs referenced in my issue tilt items, MTUM offers traders publicity to large- and mid-cap shares exhibiting comparatively greater worth momentum in a low-cost ETF type. The index tracks the MSCI USA Momentum Index. That underlying index selects its constituents primarily based on risk-adjusted worth momentum over the previous six to 12 months, which is translated right into a momentum rating and weights by the constituents’ market capitalization. With an expense ratio of zero.15%, the historic outperformance would have strongly paid for the upper price of the momentum versus utilizing a decrease price cap-weighted passive fund to duplicate the market.

The long-run efficiency of the MSCI USA Momentum Index, replicated by MTUM, and its dad or mum index the MSCI USA Index (EUSA) is proven under for the longest information set I’ve obtainable. I’ve additionally added within the S&P 500 (SPY) for reference, on condition that market benchmark is what I’ve traditionally used for exploring the opposite five-factor tilts.

Long-run MTUM vs SPY Supply: Bloomberg, MSCI, Customary and Poor’s

Momentum has generated long-run absolute outperformance. Regardless of its historic greater volatility (roughly 20% greater than the S&P 500), momentum has additionally produced risk-adjusted outperformance. Whereas this graph demonstrates very robust historic efficiency for the momentum technique, a part of the outcomes are backtested or simulated. The momentum index has not been excellent for the reason that 1970s. It has a launch date of February 15th, 2013. After January’s ad-hoc rebalancing, I started to query the historic information on the momentum technique. How may the index supplier know the way their ad-hoc rebalancing would have performed out previously? I like easy rules-based ETFs the place the backtesting is easy.

The rebalancing of MTUM in January was pushed by an arcane reference in Appendix III of the MSCI Momentum Index Methodology. In a bit labeled Conditional Rebalancing, the index methodology features a path in direction of an off-schedule rebalancing that seeks to mitigate drawdowns during times that includes sparks in market volatility like what we skilled within the again half of the fourth quarter. 9 enterprise days earlier than month-end, the annualized volatility over the previous three months of the broad MSCI Index is calculated. If vol is above a sure threshold, 95% of month-to-month modifications in volatility over the index historical past, an ad-hoc rebalancing is triggered. At that time, solely 6-month volatility and never a mixture of 6- and 12-month volatility is used to type the portfolio.

Whenever you have a look at the historic efficiency of the momentum index, you get a really feel about why this Conditional Rebalancing coverage was instituted.

Historical returns of Momentum stock strategy

The final six damaging years for the S&P 500 (in pink – 2018, 2008, 2000-2002, 1990) had been preceded by years the place the momentum technique strongly outperformed. Momentum rides the recent hand within the mid-to-late a part of a enterprise cycle. That makes the technique liable to crashes when the economic system rolls over. That is presumably why this index supplier inserted the Conditional Rebalancing provision – to catch the outperformance afforded by momentum in up-markets, however higher place the technique for potential shifts in sentiment. Realized volatility kinds a set off for this rebalancing. In a mathematical sense, volatility tends to cluster, making this a wise enchancment to the technique.

Critics may definitely counter that the volatility set off was utilized by the index supplier to suit to the historic information and produce higher long-run returns. Individually, I feel the connection between the outperformance of momentum and subsequent drawdowns by the broad market is an interesting commentary, and imagine that this vol set off is a worthwhile enchancment to the technique. I’m going to stay an investor within the ETF as a complement to my allocations to low volatility and dividend development methods. Given momentum’s tendency to steer downturns, following this index has advantage on a standalone foundation. I may even look to make use of this discussion board to judge the deserves of future conditional rebalancing instituted by this more and more common automobile.

Disclosure: I’m/we’re lengthy MTUM,SPLV,SPY. I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (apart from from In search of Alpha). I’ve no enterprise relationship with any firm whose inventory is talked about on this article.

Extra disclosure:
Disclaimer: My articles might include statements and projections which might be forward-looking in nature and due to this fact, inherently topic to quite a few dangers, uncertainties, and assumptions. Whereas my articles deal with producing long-term risk-adjusted returns, funding choices essentially contain the danger of lack of principal. Particular person investor circumstances differ considerably, and knowledge gleaned from my articles must be utilized to your personal distinctive funding state of affairs, goals, threat tolerance, and funding horizon.

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