Combining momentum and value into a single investing process.
Momentum investors and value investors are often viewed as polar opposites. The two approaches definitely have their differences. Momentum investors buy stocks that are appreciating (showing positive momentum), while value investors generally buy stocks with depleted (undervalued) prices. Each approach looks at different calculations to arrive at target stocks, and they often function on different time horizons.
Of course, momentum and value investing also have some similarities. Both investment approaches look to hold stocks they expect to appreciate at some point in the future. Otherwise, what is the point of investing? When implemented successfully, both approaches have a repeatable process that can be used to identify target securities.
So, which process is the best? Are we better off buying stocks that already have a proven track record of appreciation, or should we buy stocks that have potentially been held below their perceived fair market value?
The correct answer could be…both. No single approach is going to be the best approach at all times. We are partial to momentum investing here at Nasdaq Dorsey Wright since it is the backbone of our investment process. We understand (perhaps better than most) that focusing on momentum does not work every time, but it can work over time when implemented consistently. Value investing often functions the same way even though the approach is different. Some periods work well for value investing, and others do not. This creates two different return streams for the two approaches. The best performing return stream will vary depending on the market environment. These two return streams are also typically inversely correlated with one another (source: Value and Momentum Everywhere by Clifford Asness et all). Therefore, combing the two return streams together can create a more consistent return profile over time.
The First Trust Dorsey Wright Momentum & Value ETF (DVLU) seeks to follow a systematic process that combines aspects of both factors into a single approach tracking our Momentum Plus Value Index. That process takes a broad inventory of US large and mid-cap equities and compares them to the market using relative strength (momentum). Once we determine which stocks pass the initial RS screen, we then rank them based on a composite value score that accounts for price-to-earnings, price-to-sales, price-to-book, and price-to-cash flow. The 50 securities with the highest value score at each quarterly evaluation are selected as the index constituents.
This process has led to positive technical development from DVLU over the past few months. The fund moved sharply lower from last December through April, giving three consecutive sell signals. However, DVLU rebounded sharply along other global equities in late April, and has continued to show consistent improvement over the past several months. The fund moved back to a positive trend in August, gave a second consecutive buy signal in November, and pushed higher to new all-time highs in December. This improvement led DVLU to a strong 5.77 technical fund score (out of 6 possible points), paired with a positive 2.82 score direction. DVLU has risen 23.68% on a price return basis so far this year, including a return greater than 7% over the past 30 days (through 12/15), highlighting the strong momentum heading into year end.
Disclosures:
This article is intended only for financial professional use only. Not Intended for retail investors.
Click here for more information from Invesco on the First Trust Nasdaq Dorsey Wright Momentum & Value ETF (DVLU): https://www.ftportfolios.com/Retail/Etf/EtfHoldings.aspx?Ticker=DVLU
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