The Power of Dual Momentum
Dual momentum is among the most effective quantitative investment strategies available to financial advisors and their clients. By combining relative strength momentum with absolute momentum, this approach offers a robust framework for making disciplined investment decisions while attempting to manage risk. Here is why Tamarisk Research attempts to incorporate momentum in our investment process.
What Is Dual Momentum?
Dual momentum combines two distinct momentum concepts:
Relative momentum compares the performance of an asset against other assets in the same class. This helps identify which investments are outperforming their peers. This is commonly referred to as relative strength.
Absolute momentum (also called time-series momentum) examines an asset's performance against its own history, typically using a benchmark like Treasury bills or a risk-free rate. This is also referred to as trend-following.
When these momentum strategies work in tandem, they create a powerful system that not only selects the strongest performers but also provides risk management through trend-following.
Key Benefits of Dual Momentum
Enhanced Risk-Adjusted Returns
Research consistently shows that momentum among the strongest market anomalies. By systematically selecting assets with positive momentum in both relative and absolute terms, advisors can potentially capture higher returns while avoiding prolonged drawdowns.
For clients concerned about portfolio volatility, dual momentum provides a quantitative approach to reducing downside risk. When absolute momentum signals turn negative, portfolios can shift to safer assets, potentially mitigating losses during significant market declines.
Behavioral Discipline
One of the greatest challenges for investors is emotional decision-making. Dual momentum removes this obstacle by implementing a rules-based system that:
Eliminates subjective judgment calls
Prevents panic selling at market bottoms
Discourages performance-chasing at market tops
Creates a consistent framework for portfolio management
Adaptability to Market Conditions
Market environments change, sometimes dramatically. Dual momentum's trend-following component allows portfolios to adapt to changes by:
Participating in sustained bull markets across various asset classes
Moving to defensive positions during prolonged downturns
Reducing exposure to underperforming asset classes
Simplicity and Transparency
Despite its sophisticated underpinnings, dual momentum can be implemented with remarkable simplicity. A basic dual momentum strategy might evaluate a handful of broad asset classes monthly, making portfolio adjustments only when momentum signals change significantly.
This transparency makes it easier to communicate with clients about portfolio positioning and changes, building trust through clear, explainable investment decisions.
Implementation Considerations
Implementing dual momentum requires attention to several factors:
Lookback periods: Most research suggests 6-12 month measurement periods work best. Too short of a lookback period is prone to overtrading and whipsaws. Too long and the momentum effect diminishes. Research shows that after about 24 months, prices tend to revert to the mean.
Rebalancing frequency: Monthly or quarterly reviews typically provide optimal results
Asset class selection: Broad, liquid ETFs representing diverse asset classes work well. The strategy also lets itself to stock constituents of an index.
Tax efficiency: For taxable accounts, consider implementation methods that minimize tax impact. While trading can expose short-term capital gains, trimming weaker positions could be losing positions providing losses.
Conclusion
As quantitative approaches continue to demonstrate their value in investment management, dual momentum stands out for its elegant combination of offensive and defensive elements. By incorporating relative strength selection with trend-following risk management, advisors can offer clients a disciplined approach to navigating complex market environments.
For retail financial advisors looking to deliver institutional-quality investment management, dual momentum provides a proven quantitative framework that aligns with best practices in modern portfolio theory while addressing the behavioral challenges that often derail investment success. Tamarisk Research is a big proponent of incorporating momentum into our investment framework.
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Tamarisk Financial, LLC is a registered investment advisor dba Tamarisk Research. The advisor may transact business in states where it is appropriately registered, or where it is excluded or exempted from registration. Information presented is for educational purposes only and is not an offer or solicitation for the sale or purchase of any securities or investment advisory services. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial adviser or a tax professional before implementing any strategy discussed herein.