Our Momentum strategy employs a quantitative, price momentum based rotation model for sectors and indexes developed by Marty McClelland. The objective is to achieve attractive rates of return while controlling risk. This model was originally developed based on seven years of market data from 1990 through 1996, and it has been continuously refined and managed since 1997.
During any period of time, there are groups of similar securities ("sectors") that outperform the market averages. These periods of outperformance can last for as long as one year or more. Often, even in flat or down markets, selected sectors perform well. For example, if high oil prices threaten economic growth, at least one of the energy related sectors should perform well. If commodity inflation pressures the market, the precious metal sector should outperform. The investment strategy is designed to capitalize on this behavior. The years 2005 and 2007 provide examples. The market was up approximately 5% in both 2005 and 2007, and the strategy significantly outperformed in each year - based on a heavy focus on energy-related sectors and gold.
We monitor over 75 index, sector and exchange traded funds daily and identify those funds exhibiting the most momentum over short, intermediate and long-term periods. We invest in the top-performing funds, and hold each as long as it remains in the set of top performers.
Our sell decision is based entirely on long-term momentum to avoid unnecessary volatility caused by temporary, short-term moves. When a fund falls out of the set of top performing funds, we sell it and replace it with a fund from the set of then top performers. In cases where no funds are demonstrating positive momentum, the strategy invests in a money market fund to protect against excessive losses. When we are fully invested, we employ "stop loss" triggers for risk control.
The Momentum strategy typically outperforms in sustained upward-trending markets characterized by consistent market leadership. Where the strategy typically underperforms is during market transitions such as early 2003 (bearish to bullish) and 2009 (bearish to bullish). The strategy would likely underperform the market in an environment where no sectors demonstrate a sustained upward move and individual sectors repeatedly rally only to quickly decline to price levels below where the rally began.