Abstract
There is overwhelming empirical evidence on the existence of country and industry momentum effects. This line of research suggests that investors who buy country and industry portfolios with relatively high past returns and sell countries and industries with relatively low past returns will earn positive risk-adjusted returns. These studies focus on country and industry indexes that cannot be traded directly by investors. This raises the question of whether country and industry momentum effects really can be exploited by investors or whether they are illusionary in nature because they exist only on non-tradable assets. We analyze the profitability of country and industry momentum strategies using actual price data on exchange traded funds (ETFs). We find that over the sample periods during which these ETFs were traded, an investor would have been able to exploit country and industry momentum strategies with an excess return of about 5 % per annum. These returns cannot be explained by unconditional exposures to the Fama–French factors. The daily average bid-ask spreads on ETFs are substantially below the implied break-even transaction cost levels. Hence, we conclude that investors who are not willing or able to trade individual stocks may use ETFs to benefit from momentum effects in country and industry portfolios.
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Notes
See Swinkels (2004) for an overview of research on momentum investing. Pettengill et al. (2006) suggest that momentum strategies are not viable for individual investors. Siganos (2010) finds that for small UK investors the momentum effect can be exploited when focusing on the most extreme momentum stocks. Ammann et al. (2011) construct feasible momentum strategies in the United States by focusing on the largest 100 stocks, which are generally cheaper to trade than the rest of the stock market. Rey and Schmid (2007) construct feasible momentum strategies for the Swiss stock market.
As far as we know, private investors do not have the opportunity to engage in an individual momentum strategy by purchasing a mutual fund or exchange traded fund that solely focuses on this strategy. The AQR Momentum Fund (AMOMX) is a notable exception, but requires at least $5 million as an initial investment (source: Morningstar).
De Jong et al. (2008) also investigate momentum effects using ETFs. However, they investigate momentum across asset classes instead of country and industry momentum within equity markets.
In this paper we focus on US industry momentum. Swinkels (2002) shows that industry momentum strategies are also profitable when using non-tradable industry indices provided by Thomson Financial for the United States and Europe and, to a lesser extent, Japan. Giannikos and Ji (2007) investigate industry momentum strategies for many more countries and regions, and conclude that industry momentum is globally present. Doeswijk and Van Vliet (2011) confirm 1- and 12-month momentum effect for 10 global-sector indexes.
Results with a 1-month skip between formation and investment period are available in Table 10 of the Appendix. The results are qualitatively similar to those without skip presented in the main text.
Nijman et al. (2004) report that for momentum strategies within Europe, country momentum is virtually nonexistent once industry momentum effects are taken into account.
Results with a 1-month skip between formation and investment period are available in Table 11 of the Appendix. The results are qualitatively similar to those without skip presented in the main text.
We conduct a robustness analysis by also using the iShares ETFs, which track the Dow Jones US Sector indexes. The economic and statistical significance of these ETFs is similar to the results reported here. The results are available upon request from the authors.
Results with a 1-month skip between formation and investment period are available in Table 12 of the Appendix. The results are qualitatively similar to those without skip presented in the main text.
The trading costs analysis reported here assumes that fixed trading costs are negligibly small. Since the returns from the trading strategies are monthly and overlapping, actual trading occurs each month, but only for a small part of the portfolio. If fixed trading costs are high, this could further reduce trading profits.
The relation between time variation in transactions costs and excess returns in international equity markets is analyzed by Gosh et al. (2009).
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Acknowledgments
We thank Roque Vanda, participants of the 2011 EFMA Annual Conference in Braga (Portugal), and an anonymous referee for helpful comments. The views expressed in this paper are those of the authors and do not necessarily represent the views of the companies with which they are affiliated. This paper was written while Andreu was a visiting scholar at Erasmus School of Economics. She acknowledges financial support from DGA (CONAID) and CAI for the funds provided during the research programme CAI Europe, and from the local government of Aragon and the European Social Fund (Project 268–196).
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Andreu, L., Swinkels, L. & Tjong-A-Tjoe, L. Can exchange traded funds be used to exploit industry and country momentum?. Financ Mark Portf Manag 27, 127–148 (2013). https://doi.org/10.1007/s11408-013-0207-8
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DOI: https://doi.org/10.1007/s11408-013-0207-8