Dual Momentum: 6 Month or 12 Month Lookback

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 that it is very easy for any amateur investor to follow on their own and it takes hardly 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: stocks. To keep things simple, we look at the recent historical performance of two popular broad stock indices: U.S. stocks and International stocks.

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 short-term government bonds. In Dual Momentum, we compare the recent historical performance of the highest performing asset in our relative momentum evaluation 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 short-term government bonds.

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 those T-bills. 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 be effective. 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. The markets tend to mean revert over very short and very long time periods. Longer lookback periods can reduce disruption caused by these 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%.

Combining Lookback Periods

For my own evaluation, I combine 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%.

Summary

When making a decision about lookback periods, I believe it is important not to overthink the process. You can do that by keeping your 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.

For the time being I will continue to share a system with a combined 6-month and 12-month lookback. It's easy to calculate, it is responsive, it has performed great over time, and there is no significant difference in the number of trades executed.

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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4 Replies to “Dual Momentum: 6 Month or 12 Month Lookback”

  1. Thanks for the excellent article- I’ve been reading allot about this strategy and find all of this info very interesting.

    Few questions:
    1- I can see that you’re investing in unhedged CAD ETF’s for this strategy. When comparing relative and absolute performance, are you using USD ETF’s or unhedged Canadian ETF’s? Basically, are you including fluctuations of currency in your performance comparisons, or just comparing ETF’s priced in USD, as Gary did.
    2- Do you know of an automated (or semi automated) way of calculating the 6/9 month performance every month?
    3- Do you think this strategy is still effective in a registered account? Would be subject to capital gains more frequently with more trades.

    Thanks!

    1. Daren (Editor) says:

      Thanks for reading! If you haven’t already, reading Gary’s book and blog is a great way to understand the strategy, why it works, and where the downsides are.
      1) It should not make a significant difference if you measure performance off Canadian listed unhedged ETFs, or if you use US ETFs/mutual funds. In Gary’s evaluation he does not use a hedged version of the International stocks to strike the currency factor on the US side. This means both are evaluated absent currency adjustments in US dollars. I think the bigger issue that may slightly change some of the signals is the difference in cost between Canadian listed international stock ETFs and US listed international stock ETFs. Right now the cheapest international stock ETF in the US is a full 12 basis points cheaper than the comparable Canadian version.
      2) I just use an Excel spreadsheet formula to average the 6-month and 12-month returns. It’s easy and takes me a minute or less.
      3) I am currently using a version of Dual Momentum in my registered accounts (RRSP & TFSAs). I think the strategy will work well on a risk adjusted basis in any account. Some capital gains will be triggered in a non registered account, but the impact of that is quite minimal as capital gains taxes here are quite low unless you have a very high income. Thankfully we don’t have the US issue where short-term capital gains are taxed at much higher rates than long-term capital gains.

  2. What is the maximum drawdown of Dual Momentum while averaging the 6 and 12 month loopback periods?

    1. Daren (Editor) says:

      The largest drawdown since 1970 (as far back as I can get International stock data) occurs from April to November 1973. If you had invested in T-bills as per the signals, the drawdown would be -19.41%. If you had invested in 10-year treasuries, the drawdown would have been -17.17%. This is mainly due to the difference in T-bill vs treasury bond returns for the month of September 1973.

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