Relying on momentum investing for long-term returns - MoneySense

Relying on momentum to deliver long-term returns

Martin adopted a long-term strategy that he hopes will propel his returns higher over time

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ME AND MY TFSA

Martin Racicot

AGE: 41
PLACE: Montreal
TFSA TOTAL: $63,500
STRATEGY: Momentum investing

Me and my TFSA

Four years ago, when Martin Racicot, a real estate investor, found himself with a bit of extra money, he opened a TFSA. “It was a no-brainer,” remembers Racicot. Already holding conservative investments in his RRSP and other non-registered accounts, Racicot was willing to take on a good amount of risk in order to maximize returns in this new account.

So after spending some time reading up on different investment styles, Racicot decided to give momentum investing a try. He was inspired by Dual Momentum Investing by Gary Antonacci and is now a faithful follower of ITAwealth.com, a web site dedicated to momentum investing. “Dual momentum is an investment strategy that uses two forms of momentum to increase returns in bull markets, and just as important, to decrease losses in bear markets,” says Racicot. “It’s a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period. I’m really enjoying experimenting with it in my TFSA.”

Here’s how it works: The strategy requires just three ETFs or index funds—an S&P 500 fund, an international stock index fund and a total bond market index fund. This makes the underlying investments both simple and cost-effective. Racicot’s TFSA funds are evenly split between two ETFs: the PowerShares QQQ, which invests in an index that tracks only non-financial stocks on the NASDAQ, and the WisdomTree Europe Hedged Equity ETF (NASDAQ: HEDJ), which tracks an index of Eurozone dividend-paying companies (but also screens for firms that get at last 50% of their sales from exports outside the Eurozone.)

Racicot likes this strategy because it follows a solid set of rules, meaning no discretionary decisions required. The approach gives him a feeling of being more in control. The relative momentum rule requires a comparison of the past 12 month returns for U.S. versus international stocks. The absolute momentum rule compares the higher trending of these two stock markets to the past 120-month returns for T-bills. If the S&P 500 has a higher return than both international stocks and cash, you hold the S&P. If international stocks have a higher return than the S&P and cash, you hold international stocks. And if cash has a higher return than stocks, you hold the bond fund.

It’s a fairly simple strategy and he only rebalances once month , which leads to a fairly low turnover compared to other momentum strategies. According to Antonacci’s book, going back to 1974, the strategy only made an average of 1.35 changes per year. It’s based on both historical evidence and investor behaviour and the numbers can be quite impressive. All good investment strategies are based on taking advantage of other investor’s mistakes and behavioural biases and this one is no different on that front.

Racicot knows the strategy is not for everyone. And even though he’s been using it for more than 18 months now, his returns have been fairly modest—about 3% net average annual returns. “For me, it’s important to understand why it works,” says Racicot. “Unless you have full confidence in a strategy and understand all the ups and downs, you won’t stick with it when it’s doing poorly. I plan to stick with it and find it fascinating. If history is any indication, returns will likely be very good over a 30 year stretch of time.”

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In fact, Racicot believes there are enough winning years that this approach is probably incrementally better over time than a standard passive portfolio. And he thought it sounds complicated, Racicot finds the method easy to follow.  “I check my portfolio every month, update my spread sheet and rebalance every 60 days,” says Racicot. “It’s in my planner and the method takes just half an hour a month to implement, which works for me.”

Of course, if a Black Swan event were to happen Racicot’s portfolio will take a big 50% hit. But he’s okay with that. (A black swan is an event or occurrence that is random, unexpected and extremely difficult to predict. It also often has severe consequences for global stock markets.) “I have a lot of non-registered holdings that are invested passively in a Couch Potato portfolio so I’m not worried,” says Racicot.

In fact, Racicot says his TFSA will be the last money he cashes in during his lifetime as he plans to hold onto it right through his 80s. “I do some real estate investing as well and that, along with my RRSP money will fund almost all of my retirement,” says Racicot. “So I’m in it for the long-term and plan to enjoy watching my money grow.”

Pro tip

Momentum is an important factor to consider, but its an unreliable strategy over the long term.

There is some evidence in portfolio management theory shows that momentum is a real factor to take into account when it comes to wanting to outperforming stock market benchmarks. But John DeGoey, portfolio manager with iA Securities warns its effect on returns can be short lived and not predictable.

“There can be long periods of time when the opposite of what you expect to happen, happens,” he says. The good news is that in a TFSA there are no tax consequences for trading in and out of your holdings several times a year, as may be necessitated by momentum. But overall, DeGoey says there’s really no good data support that you can add value this way.

The average investors may also find it hard to stay out of the market when momentum indicators say you should while stock indexes keep recording record highs. “But its more the vagaries of this strategy that appear and disappear at any time that make it unreliable,” says DeGoey. “It’s too random. And if you make some money at it, you’re likely just being lucky.”

Martin Racicot’s TFSA portfolio

First published April 15, 2017


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