Dual Momentum, discovered and popularized by Gary Antonacci, is one of the investment strategies that I endorse and personally use.
Over time, Dual Momentum has performed extremely well compared with simple buy-and-hold, lazy style portfolios. It has also outperformed most complex investment strategies and most active managers of mutual funds.
The best part about Dual Momentum is its ease of management for any amateur investor. Dual Momentum hardly requires any work at all.
Once a month you evaluate three different investable asset classes, find the highest performing of those three asset classes over a specified historical time period, and invest your entire portfolio in that asset class.
These are very broad parameters, but are based on verifiable academic research. Dual Momentum is branded as such because it evaluates two simple forms of momentum: relative momentum and absolute momentum.
Relative momentum is the comparison of two assets within the same broad asset category. For the purposes of Dual Momentum, our relative momentum category is the equity universe: the U.S. stock index compared to the International stock index.
Relative momentum evaluations are not exclusive to broad stock indices. For example, if you compare the recent historical performance of Apple, Inc. (AAPL) and Microsoft (MSFT), you would also be conducting a relative momentum evaluation within the large-cap tech stock asset category.
Absolute momentum evaluations are the comparison of any asset class to a risk-free asset, usually represented by Treasury bills. In Dual Momentum, we compare our relative momentum evaluation winner to the recent historical performance of short-term government bonds.
Once you have determined the preferred asset after your relative momentum and absolute momentum evaluations, you would ensure your entire portfolio is invested in that preferred asset. If you already hold that asset (which is the case the majority of the time), you would do nothing that month. If you hold a different asset, you would sell the asset you have and purchase the asset dictated by your Dual Momentum evaluations.
Dual Momentum Variables
In Dual Momentum there are two main variables to consider that will impact your strategy in a meaningful way.
The first is choosing the lookback period you will use to determine your momentum evaluations. We'll cover a bit of that in this post.
The second is choosing the number and type of investment assets you will track. I have talked about that a bit in the past, but will do a new post in the future.
For the purposes of this post, we'll maintain the standard asset classes that Gary Antonacci has set out: U.S. stocks vs. International stocks, and the winner of that evaluation goes up against Treasury bills.
It's worth pointing out Antonacci introduces a small twist on the bond part. While he uses short-term government bonds (T-bills) when conducting his absolute momentum evaluation, he actually invests in the broad bond universe when the signal is in the risk-free asset. This small change increases overall returns over time.
Choosing Lookback Periods
One variable that is always up for debate with any momentum analysis is choosing the best lookback period to use when evaluating historical performance.
Gary Antonacci advocates a 12-month lookback period when sharing his strategy with the investing public. However, he also has made it clear he offers more responsive programs to institutional investors which purchase his services as a investment consultant.
Academic papers have evaluated lookback periods quite intensively. While the exact conclusion can depend on the asset being evaluated and the time frame used for the academic analysis, it is generally agreed that a lookback period between 3 months and 12 months can offer a momentum based advantage for investors. This is to say, assets which have outperformed in the past three to twelve months continue outperforming relative to other assets for some future time.
I don't disagree with Gary's public assertion to just go with 12 months because it is generally good. Something like choosing a time frame for performance evaluation can become a bit of a cherry picking exercise.
Maybe the ideal is 6.5 months for U.S. stocks between 1970 and 1996 and 11 months from 1996 until today. International stocks might be 10 months until 1988 when Emerging markets were added and just 5 months since that time. I don't know... but you get my drift here.
At the end of the day, you need to choose a standard metric that works generally well across all assets being evaluated.
Shorter Lookback Period
There are a few benefits to using a shorter lookback period. A short period will translate to a more responsive system. The signals are changing much quicker from month to month. This means you will have more trades.
At some point, the investor using short lookback periods will end up actually losing their performance advantage thanks to whip-saw trading. You are in one asset, get bounced out of that holding after a bad month, during the month you are out the first asset does very well compared to your new holding, and at the end of the month your evaluations put you back into the first asset again. If you would have simply held on, you would be better off.
For example, using a 6-month lookback since 1970, a simple Dual Momentum system would have counted a little over 100 trades. The largest drawdown would have occurred in the 1987 period with a -22.3% drop on a monthly calculated basis.
Longer Lookback Period
Using a longer lookback period, your system will be less responsive to changes in the market which occur in more recent months. The signals will change much slower, resulting in fewer trades.
This has pros and cons. Academic studies show that markets have mean reversion characteristics in short time-frames and over very long time periods.
Longer lookback periods can reduce disruption caused by short term mean reversions.
However, a drawback of a longer lookback period will occur when the market has a fast run up quickly followed by a steady fall down over a period of several months. You may be in a trade through the worst drawdown periods, only to get signaled out of the asset when it is recovering.
This was the case in 1987 where Dual Momentum would have moved you out of equities for a few months in the beginning of 1988, way to late to avoid the October/November Crash. By the time you were cycled out of equities in that fast crash, the market was in full recovery causing more portfolio damage.
If you use a 12-month lookback system since 1970, Dual Momentum would have counted fewer than sixty trades in 48 years. The largest drawdown on a monthly basis would have occurred in the 1973-1974 bear market with a loss just under 20%.
Time Averaged Dual Momentum - Combining Lookback Periods
For my own evaluation, I use both the 6-month and 12-month historical performance of each asset class by averaging the two period performances.
Using performance data since 1970, this strategy results in just four more trades being made over those 48 years when comparing to a simple 12-month lookback.
When comparing the combined lookback system's trades to the simple 12-month system's trades, the combined strategy is clearly more responsive. The combined system will move to a new asset class up to four months earlier than the 12-month system.
This small difference helps add nearly 0.5% per year in compounded annual returns.
The combined system also showed a smaller drawdown in nearly all drawdown situations over 10%.
When making a decision about lookback periods, I believe it is important not to overthink the process. You can do that by keeping your investing goals in mind.
By and large, a 12-month lookback period is fine. It gets you out of the market for those long painful bear markets, exactly like the kind we've experienced in 2000-2003 and 2007-2009 and will experience again at some point in the future.
It's easy to debate a half percentage here, or one percent there to find the "best" system out there. It all becomes largely irrelevant when the system is doing what it should: getting you out of a bear market at a 10% or 15% drawdown and helping you avoid the nasty 30% or 50% drawdowns that make serious dents in your financial situation.
The system I use is my Time Averaged Dual Momentum model--the system with a combined 6-month and 12-month lookback. Time Averaged Dual Momentum is easy to calculate, it is responsive, it has performed great over time, and there is no significant difference in the number of trades executed. Until the evidence demonstrates otherwise, I will predominantly share this system on the blog.
Dual Momentum based on longer lookback periods (combined or not) works well. It handily beats the S&P 500 over full market cycles, it beats passive buy-and-hold portfolios, it significant reduces drawdowns on your portfolio, it is very low cost, and it is an easy system to run in any self-directed portfolio.
Comments & Questions
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