Dual Momentum: Changing the Assets

Although Dual Momentum is often thought of as a prescribed investment strategy, it is in fact a concept on how to evaluate the recent performance of various asset classes to each other using two measurements of price momentum.

In traditional Dual Momentum—as popularized by Gary Antonacci—there are just three assets being evaluated based on the prior 12-month return.

The momentum measurements used are relative momentum and absolute momentum. Relative momentum, sometimes also referred to as cross-sectional momentum, compares the recent performance of two assets which are broadly in the same asset class. Absolute momentum, also called time-series momentum, compares the recent performance of one asset to the risk-free rate of return (represented by T-bills).

Dual Momentum was coined as such because the strategy uniquely uses both forms of momentum. Relative momentum is the first step of the Dual Momentum process where two broad equity categories—U.S. stocks and International stocks—are evaluated against each other. The best performing of those two assets are then evaluated on an absolute momentum basis to ensure positive performance over the risk-free rate of return.

Why Just 3 Assets?

Just as momentum can be evaluated on various time frames, the principles of Dual Momentum can be applied to nearly an infinite number of investment assets. You could compare individual stocks (RY.TO vs. CM.TO), equity sectors (XEG.TO vs. XMA.TO), bonds (XSB.TO vs XLB.TO), metals (CGL-C.TO vs SVR-C.TO), and so on. You could also mix these different classes or add them to standard Dual Momentum.

Given the endless possibilities, why does Gary just evaluate three different major asset classes?

For a few simple reasons, to reduce whipsaw costs, to reduce drawdowns, and keep the program simple to follow. Also, if there is any benefit to adding more assets to track, it is extremely minimal and comes with certain costs.

Here are a few examples adding different asset classes such as precious metals, separating emerging markets and developed markets, and adding real estate.

Backtest Results: Basic Dual Momentum (20 years)

Annual CAGR: +9.98%
Largest Drawdown: -18.93%
Sharpe Ratio: 0.70

Backtest Results: Dual Momentum Separate Developed and Emerging (17 years)

Annual CAGR: +11.86%
Largest Drawdown: -24.68%
Sharpe Ratio: 0.77

Backtest Results: Basic Dual Momentum + Precious Metals (20 years)

Annual CAGR: +11.82%
Largest Drawdown: -44.66%
Sharpe Ratio: 0.53

Backtest Results: Basic Dual Momentum + Real Estate (20 years)

Annual CAGR: +10.20%
Largest Drawdown: -22.09%
Sharpe Ratio: 0.65

Backtest Results: Dual Momentum + Precious Metals + Real Estate (17 years)

Annual CAGR: +9.93%
Largest Drawdown: -44.66%
Sharpe Ratio: 0.46

As you can see by the results, on a risk adjusted basis the standard Dual Momentum model shows fantastic results while keeping very low drawdowns.

Over the comparable time period, Dual Momentum beat an equal weight portfolio (1/3rd U.S. stocks + 1/3rd International stocks + 1/3rd Total Bonds) by more than 3.5% annually compounded. Not only that, the maximum drawdown with Dual Momentum was just one-third the size of the drawdown of the equal weight portfolio.

Adding more components can actually harm rather than improve investment returns. For example, adding precious metals to the standard Dual Momentum will increase returns by 1.84% annually—albeit with significantly larger drawdowns.

However, adding a fifth diversifying asset class to the Dual Momentum portfolio—real estate—actually reduces returns a bit while drastically increasing drawdowns. It also results in twice as many trades over the same time period. Many of those trades have negative returns for the holding period where it would have been better to hold the original asset. These are considered whip-saw trades and can do considerable damage when repeated frequently.

Understanding the Objective

The purpose of Dual Momentum, the standard three asset version, is not to only obtain maximum investment returns. The best way to get better returns is with leverage (and more risk), not applying momentum.

The goal of Dual Momentum in my estimation is to provide higher risk-adjusted returns. That is, larger returns than the standard indexing or buy-and-hold approach with lower drawdowns and volatility.

When it comes to choosing your personal investment approach, it is very important to evaluate your investment goals and what you expect your investment strategy to provide. There are the so-called robo-advisers and Vanguard Portfolio ETFs for the minimal efforts folks out there. The issue is managing drawdowns.

If you are worried about large drawdowns, you can choose a conservative allocation and get reasonable returns. With a standard indexing buy-and-hold approach, you would need at least 60% of your portfolio in bonds to bring drawdowns under 20%.

A conservative allocation like that would have generated an annual return of approximately 8.9% since 1972 for a real inflation-adjusted return of 5.2%.

However, if you don't mind doing a few quick calculations once a month and changing your investment holding once or twice per year, the standard Dual Momentum strategy would have returned over 17% annually. That's an inflation-adjusted return of 13.5% over the same time period.

Results Matter

A $100,000 portfolio invested in a conservative buy-and-hold approach in 1972 would have grown to a respectable $5,050,000 today.

That same $100,000 invested in standard Dual Momentum would be worth $148,140,000 today. Thanks to greater compounding returns and lower drawdowns, you would be a centi-millionaire rather than a regular middle-class fogey.

Dual Momentum does an excellent job helping investors avoid those large drawdowns of prolonged bear markets. For example, the market cycles over 1973-1974, 2000-2003 and 2007-2009 downturns were perfect for Dual Momentum.

The standard three-fund Dual Momentum strategy accomplishes its objective very well with minimal effort. Adding more assets to the strategy adds to drawdowns and trading frequency—two very big drawbacks for your typical self investor.

Comments & Questions

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6 Replies to “Dual Momentum: Changing the Assets”

  1. Hi Daren,

    How would you go about using leverage with DM?

    I use a version of DM called GEM70 in which 30% is always invested in bonds and the remaining 70% gets allocated by the classic rules of DM. I was thinking to borrow an amount enough to cover the 30% of bonds (of a total portfolio) while allocating all my funds to the portion that follows DM. What do you think of this?


    1. Daren (Editor) says:

      I think you could practically do it two ways. The first is using margin (only worthwhile in a non-registered account). The second is by purchasing a 2x or 3x leveraged ETF and a regular ETF to hit your target 100% allocation. For example, if using 3x ETFs, it would be 15% 3x ETF plus 55% regular ETF. However, this means making two transactions each time and the results won’t match perfectly because of daily leverage factors.

  2. Daren, I don’t get the 17% DM returns when none of the profiled asset combinations get that high. Is this due to rebalancing every 6 months?

    1. Daren (Editor) says:

      It is because of the combination of relative and absolute momentum. For most periods of large bear markets, you are in T-bills or bonds which often generate a positive return during equity bear markets. During equity bull markets, you are often in the equity asset which is performing the best.
      For example, in the period 1995-1999, you would have been fully invested in U.S. stocks for nearly the entire period. In the invested period, U.S. stocks generated a 177.6% total return, while international equities generated a 37.4% total return.
      Then, in the period 2003-2007 you would have been fully invested in International equities. In the invested period, international stocks generated a 146.2% total return while U.S. stocks generated a 61.4% total return.

  3. Hi Daren, I was just wondering how the best CAGR was under 12% (separate Developed and Emerging) yet in the paragraph just before “Results Matter” you wrote that DM would have delivered 17% returns. Different time frames? More frequent rebalancing? Just wondering what gives the boost from 12 to 17.



    1. Daren (Editor) says:

      Yes it’s a timing period difference. The ~17% return is 1970-2017, and that uses pure index data so no fees or taxes are included.
      The period I used in this post was a quick calculation on a free backtest platform which only has data from 1998-2017 or 2000-2017, depending on the asset. It uses real mutual funds, so there is also an adjustment for management fees.

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