- Momentum and Minimum Volatility factors have underperformed the market by the most out of any other factor in 2023.
- Excess return correlations for Momentum and Minimum Volatility factors spiked this year, deviating from historical low to negative correlations.
- Strategy design, rebalancing frequency, and prior-year market trends are the likely causes of the increased correlation.
Momentum stocks are typically viewed as higher risk assets that behave differently than lower risk Minimum Volatility exposures. But this year, Momentum and Minimum Volatility are the only ones across the traditional four factors trailing the market by double digits.1 With only a 3% and 5% gain in 2023, they are down 17% and 14%, respectively.2
As a result, their correlation of excess returns has spiked to an average 71% for all of 2023.3 This compares to a historical excess return correlation of just 9.6%,4 putting this year’s behavior at odds with historical trends and the generalized views of factor frameworks.
Will this correlation continue into 2024?
The basic premise of factor investing is that certain factors (Value, Momentum, Quality, and Minimum Volatility) represent premia that can add to returns over a long-term horizon. Yet, cyclical shifts can impact short-term returns, leading to periods of underperformance versus the market.
Factor investing also provides potential diversification opportunities. But when return trends break down as a result of cyclical market shifts, so do the potential diversification benefits. That’s happening now with Momentum and Minimum Volatility exposures.
Using rolling 90-day correlation of 90-day excess returns to the S&P 500 Index (removing outliers and general market beta from two long-only exposures), Momentum and Minimum Volatility stocks have not been this correlated in a calendar year since 2002. The average correlation in 2023 has been 71%, compared to long-term average 9.6% (Figure 1).
The Impact of Factor Construction
Factor construction (e.g., market neutral, beta neutral, long-only, sector neutral, high capacity versus high concentration) alongside attribute selection (e.g., price-to-book versus price-to-sales for value investors) can lead to different profiles, returns, and relationships to other factors. Yet, the same trend for Momentum and Minimum volatility factors exists even if different construction methodologies are used.
The above MSCI-based Momentum and Minimum Volatility exposures are rebalanced semi-annually and use different descriptors for the intended factor focuses than what the S&P 500 USA Momentum Index and the S&P 500 Low Volatility Index use. The latter of which also rebalances annually.
For those two S&P based factor types, the 2023 average correlation is also 71% versus a long-term average of -2%.5 Point being, the factors’ co-movement is consistent across other factor frameworks.
But the co-movement has begun to rollover and mean revert. The rolling 90-day correlation of 90-day excess returns has declined in the last few weeks and is now below the historical median (Figure 2). The same trend exists if we use the S&P-based factors.
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What’s the Increased Correlation Between Momentum and Minimum Volatility Mean?
Footnotes
1 Value, Quality, Momentum, and Minimum Volatility.
2 Bloomberg Finance L.P. as of December 11, 2023, based on the S&P 500 Index, MSCI USA Minimum Volatility Index and the MSCI USA Momentum Index.
3 Bloomberg Finance L.P. as of December 11, 2023, based on the S&P 500 Index, MSCI USA Minimum Volatility Index and the MSCI USA Momentum Index 90-day rolling 90-day excess return correlations.
4 Bloomberg Finance L.P. as of December 11, 2023, based on the S&P 500 Index, MSCI USA Minimum Volatility Index and the MSCI USA Momentum Index 90-day rolling 90-day excess return correlations.
5 Bloomberg Finance L.P. as of December 11, 2023, based on the S&P 500 Index, S&P 500 USA Momentum Index and the S&P 500 Low Volatility Index 90-day rolling 90-day excess return correlations.
6 Bloomberg Finance L.P. as of December 11, 2023, based on the MSCI USA Minimum Volatility Index and the MSCI USA Momentum Index annual holdings from 2013-2023.
Glossary
S&P 500 Index
The S&P 500® Index is designed to measure the performance of the large-cap segment of the US equity market. It is float-adjusted market capitalization weighted.
S&P 500® Momentum
S&P 500® Momentum is designed to measure the performance of securities in the S&P 500 universe that exhibit persistence in their relative performance.
S&P 500® Low Volatility Index
This S&P 500® Low Volatility Index consists of the 100 stocks from the S&P 500 Index with the lowest realized volatility over the past 12 months.
MSCI USA Minimum Volatility Index
MSCI USA Minimum Volatility Index is designed to reflect the performance of a minimum variance (or managed volatility) equity strategy.
MSCI USA Momentum Index
MSCI USA Momentum Index is composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum.
Value
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
Momentum
Momentum investing involves going long on stocks, futures, market exchange-traded funds (ETFs), or any financial instrument showing upward-trending prices.
Minimum volatility
Minimum volatility investing seeks to build a portfolio of stocks that exhibits less variability than the broad market. It aims to provide investors with a smoother ride within equity allocations by creating a portfolio that exhibits less swings — up or down — than the market.
Quality
The quality factor refers to the tendency of high-quality stocks with typically more stable earnings, stronger balance sheets and higher margins to outperform low-quality stocks, over a long-time horizon.
Correlation of Excess Returns
Applying the same methodology as with a standard correlation coefficient calculation, the correlation of excess returns attempts to indicate linearity in the movement of returns above a given benchmark.
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