Last Rites for Big Mo
Is momentum investing washed up?
These are difficult times for momentum investors. A horrific 2008 put the exclamation point on an awful decade, during which their style worked in only two years, really -- three if they were lucky.
Momentum investing is based on the idea that people underestimate change, both for the better and for the worse. Practitioners typically buy stocks of companies that have surprised Wall Street by beating earnings and revenue estimates. It helps, too, if analysts are boosting their estimates. Advocates of Big Mo don't usually care much about valuation. And mo-men-tum investors are often quick on the trigger, selling at the first sign of a reversal of the pattern.
Unhappy ending. One recent sign of the growing disil-lusionment with momentum strategies came when Vanguard removed Turner Investment Partners as co-manager of Vanguard Growth Equity. The firing came nearly ten years after Vanguard adopted the fund from Turner. Had you invested $10,000 at the time Vanguard re-branded the fund in June 2000 and sold at the end of 2008, you'd be down to $4,217.
That got me thinking. If Vanguard threw in the towel on Turner, one of the best momentum investors, is the strategy washed up? It's certainly sobering that Vanguard, which has such a strong record of picking outside money managers, would choose one that turned out to be such a disappointing performer.
Elsewhere, a number of firms are turning away from momentum. AIM Funds stopped using the strategy in some funds and de-emphasized it in others after the firm got burned in this decade's first bear market. Others who played the momentum game, such as Garrett Van Wagoner, have completely given up.
What happened to momentum? The biggest problem was that its practitioners rode the Internet bubble to great heights in the 1990s, then spent most of this decade relinquishing those outsized gains. If that's the end of the story, momentum ought to enjoy a nice run over the next decade. After all, about ten years ago investors and the media were raising the same question about value managers, after they had turned in several years of pitiful performance, and many either retired or were fired. (I figure that asking about the death of momentum is my contribution to the strategy's comeback.)
But hold on. Momentum investing may also be losing its effectiveness because corporate news and analysts' estimates are now processed at lightning speed. Find a winning momentum formula and 50 other money managers may quickly copy you and eliminate any edge. Hedge funds compound the problem. They helped push up share prices to exorbitant levels, then helped force them down when the funds had to sell stocks to meet redemption requests from unhappy clients.
The good news is that the selling eventually has to stop. When it does, momentum stocks will be priced more favorably than in the past. Consider two purchases of the Brandywine fund, which incorporates some momentum elements in its stock picking. Check Point Software Technologies sold for 85 times earnings in 1999; in early February, its price-earnings ratio was 12. Gilead Sciences had no P/E in 1999 because it had no profits; today, its P/E is 21 -- not dirt-cheap, but hardly off-the-charts for a fast-growing biotech company.
I wouldn't be surprised if momentum funds snap back over the next year or two. But it's tough to maintain an advantage when speed is everything, so you should limit your holdings in funds that emphasize super-fast growth to a single-digit percentage of your portfolio. Brandywine (symbol BRWIX) is one of my favorites. So is Turner Midcap Growth (TMGFX). The expenses aren't as low as Turner's former Vanguard fund, but it has done a good job buying stocks of midsize companies, traditionally the sweet spot for momentum investors.