Investors are always on the lookout for strategies that offer better returns while managing risks. One such strategy that has gained popularity in recent years is Dual Momentum. Developed by Gary Antonacci, dual momentum combines two types of momentum strategies—relative momentum and absolute momentum—to create a more balanced and reliable investing approach. In this article, we will introduce you to the basics of dual momentum and explain how it can be a game-changer for your portfolio.
What Is Momentum in Investing?
Before diving into dual momentum, it’s important to understand what momentum means in investing. Simply put, momentum is the tendency for assets that have performed well (or poorly) in the past to continue performing well (or poorly) in the future. Investors use momentum as a signal to identify trends and adjust their portfolios accordingly.
Momentum strategies can be divided into two broad types:
- Relative Momentum: This looks at the performance of one asset relative to others over a specific time period. The idea is to invest in assets that have outperformed their peers.
- Absolute Momentum: This compares an asset’s performance against its own past performance. It focuses on whether the asset is moving upward or downward compared to its historical returns.
What Is Dual Momentum?
Dual momentum is a strategy that combines both relative and absolute momentum to improve investment outcomes. Here’s how it works:
- Relative Momentum: Dual momentum identifies the best-performing asset class (e.g., stocks, bonds, or cash) by comparing their past returns over a specific period, typically 3 to 12 months. The top-performing asset class is selected for investment.
- Absolute Momentum: After identifying the best asset class through relative momentum, the strategy checks if that asset class is still performing better than a risk-free rate (like Treasury bills or cash). If the asset’s absolute momentum is positive, you stay invested. If not, you move into a safer asset like bonds or cash.
By combining both types of momentum, dual momentum aims to capture upside potential in strong markets while protecting your portfolio during downturns.
Why Does Dual Momentum Work?
The success of dual momentum lies in its simplicity and effectiveness in multiple market conditions:
- Capturing trends: Relative momentum ensures that you’re invested in the best-performing assets, which helps you ride market trends.
- Managing risk: Absolute momentum serves as a risk control mechanism, moving you out of underperforming markets and into safer assets when needed.
Studies have shown that dual momentum has historically outperformed traditional buy-and-hold strategies by reducing drawdowns and improving risk-adjusted returns.
How to Implement Dual Momentum
Implementing dual momentum doesn’t require complex algorithms or in-depth financial expertise. Here’s a basic example of how you can get started:
- Asset Classes: Choose a set of asset classes to compare, such as U.S. stocks, international stocks, and bonds.
- Lookback Period: Use a lookback period, usually 12 months, to compare the past performance of these asset classes.
- Relative Momentum: Invest in the asset class with the highest return over the lookback period.
- Absolute Momentum: Check if that asset class’s return is higher than the return of a risk-free asset (like a 90-day Treasury bill). If it is, stay invested. If not, move into bonds or cash.
Conclusion
Dual momentum investing is a straightforward yet highly effective strategy that combines the best aspects of relative and absolute momentum. By investing in top-performing assets while avoiding market downturns, this strategy offers the potential for improved returns with less risk. In future articles, we’ll dive deeper into the mechanics of dual momentum, its historical performance, and how you can apply it to your own portfolio.
Stay tuned for more insights into the world of dual momentum!