Update Magazine III/2019 Download the complete magazine

Interview with Thomas Zimmerer, Global Co-Head of Multi Asset at Allianz Global Investors

Mr Zimmerer, what challenges are momentum-driven strategies facing at the moment?

Thomas Zimmerer: As a risk factor associated with a proven, positive risk premium, momentum remains very much alive. However, that does not mean all momentum investing strategies are in robust health. To the contrary, some of the more simplistic approaches to momentum investing might never recover – and appropriately so. Capturing the risk premium associated with momentum is no easy task, and it cannot be accomplished reliably with some of the basic trend-following strategies in use today. Many contemporary momentum strategies share some critical flaws: they rely on a single trend, usually from a constant “lookback period;” they are unidimensional, meaning that they take into account only direction, ignoring other potentially relevant factors; they operate in a single asset class; or the investment horizon they employ is too short.

Mr Zimmerer, do you believe that momentum-driven strategies can still work despite the flaws you have described? What would a more promising strategy look like?

Thomas Zimmerer: We believe that investors can improve their chances of success by adopting a more sophisticated approach to momentum. This Momentum 2.0 strategy includes the following four elements: following multiple trends with multiple lookback periods; employing a multidimensional approach; constructing a riskbalanced multi asset portfolio, and adhering to an appropriate, long-term investment horizon.

Why does it makes sense from your point of view to analyse multiple lookback periods in order to derive the right investment decisions?

Thomas Zimmerer: Research demonstrates that the optimal lookback period for a momentum strategy – the period with the most predictive power – is eight to nine months. However, research also shows that: 1) The predictive power of lookback periods fluctuates, and 2) Momentum returns for various lookback periods are less than fully correlated over time. To put it another way, there is not just one trend, but rather a number of overlapping trends whose relative attractiveness to one another changes over time. Given these findings, the most effective approach would be to use a mixture of lookback periods to determine trend signals, rather than any single “best” lookback period. A mixture of lookback periods (e.g., 1, 3, 6, 9, 12 months) yields a more stable alpha result over time than any one of these lookback periods individually.

How is a multi-dimensional approach characterised?

Thomas Zimmerer: The most popular trend concepts are one-dimensional, meaning they incorporate only a single metric direction. By contrast, trends in the actual market cycle are two-dimensional, meaning that they are characterised by the two metrics of direction and strength. Adding the concept of trend strength to a momentum strategy gives investors an important advantage because strength has an impact on trend duration.

You also mentioned the possibility of combining different asset classes in a multi asset approach.

Thomas Zimmerer: Momentum returns across asset classes normally are so asynchronous over time that their returns show virtually no correlation to one another. Using a multi asset approach therefore can deliver diversification returns with suitable portfolio construction. An optimal portfolio construction is one in which the risk budget is distributed similarly among the uncorrelated signal sources. Using that framework, with four uncorrelated signal sources and efficient portfolio construction, the excess return potential per unit of risk (risk-return ratio) could be increased significantly.

What role does the investment horizon play in your strategy?

Thomas Zimmerer: Although trend-following strategies rely on short-term, tactical portfolio adjustments to generate alpha, the goal of these strategies is to capture the long-term risk premium associated with momentum. In this context, it is important to understand the term “risk premium” correctly. The strategy will not necessarily reap the expected premium in each year; in fact, the investment return is volatile and can (and will) be negative in individual years. While the long-term target return is similar to that achieved by traditional equity and bond investments, the return pattern may be quite different. For this reason, long-term investors with an investment horizon of 10 years or more may make smaller investments in momentum strategies to create long-term diversification effects, provided that they can live with the short term “premium-related risk”.

Are you confident that your Momentum 2.0 Strategy will work in real life?

Thomas Zimmerer: In light of our research, momentum is not dead. To the contrary, it is as strong and healthy as ever. The success factors for momentum investing are multi- faceted, and go beyond the trivial task of selecting one lookback window to determine the trend of an asset class. Investors asking if momentum is dead are likely using momentum investment strategies that lack the important elements that are needed to consistently capture the momentum risk premium. Investors who adopt this more complex, comprehensive and effective model, which we call Momentum 2.0, will find that the momentum factor is very much alive, and that momentum investing can still be exploited to the benefit of investors’ portfolios.

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