Dual momentum

What Is Dual Momentum?

Dual momentum is an investment strategy within the broader field of portfolio theory that combines two distinct types of momentum: absolute momentum and relative momentum. This approach aims to enhance risk-adjusted returns by dynamically allocating capital to assets exhibiting strong positive trends while simultaneously seeking to avoid assets with negative trends or those underperforming. The dual momentum strategy seeks to capture market gains during bullish periods and reduce drawdowns during bearish phases, making it a form of tactical asset allocation.

History and Origin

The concept of momentum in financial markets has been observed for decades, with early academic studies noting its existence. However, the specific methodology known as dual momentum was popularized by investment expert Gary Antonacci. He detailed the strategy in his 2014 book, "Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk." Antonacci, drawing on decades of experience in investment management, refined the existing ideas of trend following and relative strength to create a systematic, rules-based approach that integrates both absolute and relative momentum to enhance portfolio performance and mitigate risk.¹⁰, ¹¹, ¹² His work built upon existing research on momentum as a factor in asset pricing.⁹

Key Takeaways

• Dual momentum is an investment strategy that combines absolute and relative momentum to guide asset allocation decisions.
• It aims to participate in rising markets and protect capital during downturns by moving to safer assets.
• The strategy employs a rules-based approach to select assets, often using exchange-traded funds (ETFs) for implementation.
• It seeks to enhance risk-adjusted returns and reduce portfolio volatility compared to a static buy-and-hold strategy.
• Gary Antonacci is widely credited with popularizing the modern dual momentum framework.

Interpreting the Dual Momentum

Interpreting dual momentum involves a two-step decision-making process based on the performance of assets. First, an investor assesses the absolute momentum of a chosen asset or asset class (e.g., the broad stock market). If this asset's performance over a look-back period (commonly 12 months) is positive, it signifies an upward trend. Second, if the absolute momentum is positive, the investor then evaluates the relative momentum by comparing the performance of multiple assets within a selected universe. The asset with the strongest relative momentum is chosen. If the absolute momentum of the primary asset class is negative, indicating a downturn, the strategy typically dictates a move to a defensive asset, such as treasury bonds or cash, to preserve capital. This sequential evaluation helps in both participating in strong trends and avoiding significant losses during a bear market or sustained declines.

Hypothetical Example

Consider an investor implementing a dual momentum strategy using two broad asset classes: U.S. equities (represented by an S&P 500 ETF) and international equities (represented by an MSCI EAFE ETF). The defensive asset chosen is a U.S. Aggregate Bond ETF. The strategy rebalances monthly, using a 12-month look-back period for momentum calculations.

Month 1: Initial Assessment

• Absolute Momentum Check: The S&P 500 ETF's return over the past 12 months is +15%. This is positive.
• Relative Momentum Check: Since U.S. equities have positive absolute momentum, compare the S&P 500 ETF (+15%) with the MSCI EAFE ETF (+10%) over the past 12 months.
• Decision: The S&P 500 ETF has stronger relative momentum. The investor allocates capital to the S&P 500 ETF.

Month 2: Reassessment

• Absolute Momentum Check: The S&P 500 ETF's return over the past 12 months has now dropped to -5%. This is negative.
• Decision: Because the absolute momentum is negative, the strategy dictates moving out of equities entirely. The investor allocates capital to the U.S. Aggregate Bond ETF, aiming for capital preservation during a declining stock market.

This step-by-step process demonstrates how dual momentum directs capital based on current market trends, aiming to maximize exposure to upward trends while minimizing exposure to downward ones.

Practical Applications

Dual momentum is primarily applied in portfolio management as a dynamic asset allocation strategy. Investors can use it to manage diversified portfolios across various asset classes, including global equities, fixed income, and commodities. A common application involves comparing a broad equity market index (like the S&P 500) against international equities and then, based on their absolute momentum, deciding whether to stay in the stronger equity market or pivot to a defensive asset like bonds. This systematic approach aims to remove emotional bias from investment decisions. It can be implemented using low-cost exchange-traded funds (ETFs) that track these broad asset classes, making it accessible to individual investors. The strategy is often explored in academic research and financial literature as a method for potentially improving risk management and generating favorable outcomes over various market cycles. Gary Antonacci provides resources and further information on his website detailing the strategy's mechanics and historical performance.⁷, ⁸

Limitations and Criticisms

While dual momentum aims to provide enhanced risk-adjusted returns, it is not without limitations. One criticism is that like other momentum strategies, it can experience periods of underperformance, particularly during sharp market reversals or shifts in leadership among asset classes. When previously strong trends suddenly reverse, the strategy may be slow to react, leading to losses before a defensive position is adopted.⁵, ⁶ Such "momentum crashes" can occur when markets rebound quickly after steep declines, as the system might keep capital in defensive assets, missing the initial recovery.⁴

Furthermore, the effectiveness of any momentum strategy, including dual momentum, can be influenced by transaction costs and taxes due to the potentially higher portfolio turnover. While institutional investors might mitigate these costs, smaller investors using actively managed momentum funds or frequently trading individual securities might see their returns significantly eroded.³ Critics also argue that momentum is more of a behavioral anomaly rather than a fundamental factor, suggesting its persistence is not guaranteed.² Despite efforts to improve live performance, the theoretical benefits of momentum strategies on paper do not always perfectly translate to real-world results after accounting for all market frictions.¹

Dual Momentum vs. Momentum Investing

The terms "dual momentum" and "momentum investing" are closely related but distinct. Momentum investing is a broad investment strategy rooted in the observation that assets that have performed well recently tend to continue to perform well in the near future, and vice-versa. This principle, sometimes referred to as the "momentum factor," can be applied in various ways, such as buying stocks that have outperformed their peers over a specific period (pure relative momentum).

Dual momentum is a specific, refined version of momentum investing. What differentiates dual momentum is its two-tiered filtering process, combining both absolute momentum and relative momentum. Traditional momentum investing might solely focus on identifying the best-performing assets relative to others. Dual momentum adds a critical protection layer by first checking if the overall market or a chosen asset class is in an uptrend (positive absolute momentum). If it's not, the strategy instructs a move to a defensive asset, rather than staying invested in what might be the "best of a bad lot" within a declining market. This incorporation of an explicit trend-following filter for capital preservation sets dual momentum apart from simpler relative momentum strategies.

FAQs

How does dual momentum protect against market downturns?

Dual momentum protects against market downturns through its absolute momentum component. If the chosen asset class (e.g., global equities) shows negative returns over the specified look-back period, the strategy dictates moving assets into a defensive, less volatile holding, such as treasury bonds or cash. This aims to reduce exposure to a falling market and preserve capital.

Can individual investors implement dual momentum?

Yes, individual investors can implement dual momentum. The strategy typically involves using low-cost exchange-traded funds (ETFs) that track broad asset classes like U.S. equities, international equities, and bonds. The rules are generally straightforward, allowing investors to perform monthly or quarterly rebalancing based on published methodologies.

What is the typical look-back period for dual momentum?

A common look-back period for calculating momentum in dual momentum strategies is 12 months. This period has been widely used in research and is often cited by proponents of the strategy. However, variations exist, and some investors might explore other look-back periods based on their analysis or specific objectives.

Is dual momentum a form of diversification?

Dual momentum can enhance diversification by dynamically allocating across different asset classes (e.g., stocks and bonds, or U.S. vs. international equities) based on their performance trends. While it may concentrate capital in a single asset class at any given time, the underlying mechanism allows for systematic rotation, which can be seen as a form of dynamic diversification over the long-term investing horizon.