Dual Momentum: Easy Trend Investing That Works

Edited Photo. Source: Flickr - Ollie Harding

One form of trend investing I really love for many reasons is Dual Momentum Investing. I've wanted to talk in detail about this strategy for a long time because it is the one investment strategy I would happily recommend to all my friends regardless of their financial prowess and net worth.

It provides great results, it is easy to administer, it is pervasive, and it really reduces the kind of portfolio volatility that makes many investors do stupid, stupid things.

It might be the near-perfect solution to many self-directed investor problems – particularly human psychology.

Dual Momentum Background

The Dual Momentum strategy was brought to the public by Canadian money manager Gary Antonacci. He wrote a detailed white paper on the strategy a few years back and then published a book on the strategy as well.

His website explains the strategy in good detail and has his white papers posted for your reading pleasure.

The great thing about Gary is that he expects nothing for this strategy which is simple and has handily outperformed the broader stock market over whole market cycles (top-to-top or bottom-to-bottom).

Hearing several podcasts featuring Gary and reading his blog faithfully, I genuinely get the impression that Gary is an all-around good guy who shares this great information because he cares to make the investment returns of amateur self-directed investors better.

Gary is also super blunt. When criticized by many over the pervasiveness of the strategy over say buy-and-hold, his answer is simple: I'll be the first to tell everyone to ditch the strategy when it actually underperforms a whole market cycle. (This hasn't happened yet).

Dual Momentum Results

Based on Gary's data – which is done in U.S. dollar terms only – the Dual Momentum strategy has returned over 17% annually compounded since 1974. That beat the MSCI World IMI Index by more than 5% annually over 4 decades!

Putting that into real money perspective, if you follow my minimum savings rules and put away $562 a month for 35 years, a regular buy-and-hold strategy would net you about $800,000 in today's dollars at 6% net return.

With Dual Momentum, if historical returns stayed the same, you would have $8.2 million! That's a whopping 10x difference over time: the real power of compounding interest!

But even more appealing to me is this strategy has not had a draw-down of more than 20% since 1974. To get a comparable max draw-down with buy-and-hold investing, your portfolio would have consisted of more than 60% bonds. That would have left just 40% for the higher growth stock allocation.

A lot of investors can tolerate a 20% loss without too much panic. Sure losing $100,000 on a $500,000 portfolio stings, but you can probably carry on with your plan.

Losing half your portfolio is what makes people go squirrelly, panic, dump everything into GICs, and moan and bitch to everyone who lends them an ear about the dangers of stocks and why their house is a so much better "investment".

Basics of Dual Momentum

Dual Momentum investing is based on considering two factors: relative momentum and absolute momentum. The strategy evaluates just three asset classes: U.S. stocks, international stocks, and cash using three different ETFs.

Basically you consider momentum factors and then invest 100% of your portfolio in the ETF which has performed the best over a specified period of time.

Historically the invested asset class has changed just over once per year. This means minimal trading costs and little stress about picking the right day to evaluate. It really doesn't matter whether you are religious about checking in on your portfolio the first trading day of each month, or if you let it slip a few days every now and then.

For Canadians, I would suggest the best options for evaluation today are: XUU.TO for U.S. stocks, XEF.TO for international stocks, and VSB.TO for short-term bonds.

Once a month we evaluate our options and choose the best performing ETF for our portfolio holding. It's extremely simple and very effective.

I am comfortable saying those who are okay doing something just a bit different but don't want to be a dedicated trader, Dual Momentum may be the best long-term sustainable choice.

Evaluating Relative Momentum

Relative Momentum means comparing the historical performance of an asset with its peers over a specified time period.

While opinion differs on the timeline that should be used, I personally like looking at the past 12 month performance and the past 6 month performance and averaging the two.

This is where we evaluate the total return performance of the two stock asset classes: XUU.TO and XEF.TO.

Here is the comparison as of July 31, 2017:

  • XUU.TO 6 month: +4.13%
  • XUU.TO 12 month: +11.11%
  • XUU.TO Average: +7.62%
  • XEF.TO 6 month: +9.54%
  • XEF.TO 12 month: +13.22%
  • XEF.TO Average: +11.38%

By this relative momentum evaluation, XEF.TO is the clear winner. Therefore XEF.TO is our choice for the stock asset class.

However, we are not done here. Now we need to evaluate the performance for the absolute momentum side.

Evaluating Absolute Momentum

Absolute Momentum is the evaluation of an investable asset's performance compared to cash (T-bills) over a specified time period. Again, I like averaging the 12 month and 6 month performance.

T-bills (very short-term government bonds) are used here because they are widely perceived to be a nearly risk-free asset class. I feel the Vanguard Short-term Bond Index ETF, trading as VSB.TO, does a decent job of substituting for T-bills in this evaluation.

Some other writers, including Antonacci himself, compare to T-bills but choose a broad bond index for their investment choice. To me, using VSB.TO for our comparison and investment choice is easier and just as effective.

Here is the comparison as of July 31, 2017:

  • XEF.TO 6 month: +9.54%
  • XEF.TO 12 month: +13.22%
  • XEF.TO Average: +11.38%
  • VSB.TO 6 month: -0.31%
  • VSB.TO 12 month: -0.59%
  • VSB.TO Average: -0.45%

In this absolute momentum evaluation, XEF.TO is again the clear winner.

So, currently you would have 100% of your portfolio invested in just one ETF: XEF.TO – giving you an indirect stake in 2,500 companies located across Europe, Australia, and Japan.

I will be publishing the Dual Momentum recommendation every month alongside the Balanced Portfolio post. I would suggest every reader at least give this strategy serious consideration.

I personally believe it is likely to perform well compared with buy-and-hold over our lifetimes. This simplicity of the strategy can't be argued with.

*Of course you should always do your own due diligence to see if this is right for you. I don't know your personal financial situation*

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