Momentum Strikes Back

Next month's Morningstar Investment Conference will include a panel focused on momentum investing, and though it's not by design, the timing seems fortuitous. After cratering during the market's 2008 meltdown and flailing (in relative terms) in 2009, the tactic has lately picked up steam. AQR Momentum AMOMX--probably the mutual fund world's purest price-momentum vehicle--bested the Russell 1000 and Russell 1000 Growth indexes last year. It snagged a spot in the large-growth category's top quartile, too.

Secrets of Its Success
At a glance--and if "momentum" weren't in the fund's name--you might conclude its recent success owes to a big bet on energy stocks. Which it does. Sort of.

At the end of March, energy accounted for 27.5% of the AQR fund's assets--more than double the benchmarks' exposure. That big weighting doesn't reflect management's views on the sector, though. The team overseeing the fund doesn't override the quantitative inputs. Rather, the portfolio is composed of the top third of domestic large- and mid-cap companies as ranked according to their share-price performance during the preceding 12 months. If that leads to a sector overweighting, they won't bring it back in line.

Tech companies are plentiful, too. But with energy the best-performing area of the market during the last year, it's not surprising to find the sector well-represented in the fund's portfolio. Also no surprise is that AQR Momentum ranks among the category's poorest performers during the last month, a stretch in which energy stocks as a group have tanked.

Reversal of Fortune
As that example illustrates, momentum investors can quickly find themselves in the wrong place at the wrong time when what was working suddenly stops. Yet notwithstanding the occasional downward lurch, price momentum has generated substantial excess returns over the long haul -- at least on paper.

A white paper published last year by GMO quant Tom Hancock (one of our upcoming panel's participants) revealed that, between 1927 and 2009, a strategy similar to the one in play at AQR Momentum would have outperformed the broad stock market at an annualized clip of 4%.

Past isn't necessarily prologue, but that's an impressive track record. And of course for those inclined to hedge a momentum bet in hopes of avoiding the tactic's inflection-point vulnerability, it's always possible to use momentum (which comes in flavors other than AQR's price approach) as simply one more tool in a wider-ranging investment approach.

That's the practice at the fund shops founded by our panel's other participants, Steve Leuthold, of Leuthold Weeden Capital Management, and John Montgomery, who hails from Houston-based Bridgeway Capital Management.