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By Paul Justice, CFA | 07-01-2011 11:36 AM

Combining Value and Momentum

Value investors might want to consider allocating a small portion of their portfolios to a momentum strategy, says Russell's Ed Rosenberg.

Paul Justice: Value and momentum, oil and water, or a possible solution for folks. Hi there, I am Paul Justice with Morningstar, director of exchange-traded fund research. Today, I am joined by Ed Rosenberg from Russell Investments. We're going to talk about a few of the factor ETFs that you've brought forward and really talk about how they can fit into some people's portfolios. What I'd like to talk about today is the momentum factors that you now have and how they can possibly mix in with the value investor portfolio.

Ed Rosenberg: Sure. So when you think of your traditional value investor portfolio, one of things you may come across is that individual might be missing out on certain segments of the market or might be under momentum without even realizing it and have a negative momentum exposure. Such things as common stocks you may associate with momentum would be like Apple, for example.

So if I am a typical value investor, it's a portion of the market I might be missing. What I can do to capture that market is add a little bit of momentum to the portfolio, so that I can gain exposure to those segments and I can control how much I add. I might do 2% of the portfolio or 5% of the portfolio, so I still have a very strong value bias, but I'd be adding back in a little bit of momentum to capture certain aspects of the market. Maybe it's a certain upside that I might be missing, or maybe it's certain securities that I'd like to capture in my portfolio.

Justice: Now let's talk about a little bit of the relationship between value and momentum factors over time. Is there one strategy between the two that is more effective all the time or does it make sense in a portfolio to have some exposure to both?

Rosenberg: Well I think it's really up to the individual advisor. And again relating back them, it's up to their individual client. Momentum is a key piece to the portfolio if the advisor or the ultimate investor sees value and having it in the portfolio. These products are designed to enhance or mitigate specific strategies, momentum being one of them. Is it possible that I am missing out on momentum by just being a pure value investor? Absolutely. But I also may have a client base that doesn't feel that it fits in the investing strategy. So it's really going to come down to the ultimate value of the client, but I would say overall, for the advisor to look at it, he should at least take a look at it because it doesn't hurt to look and see if there is value in adding it to that portfolio. This is because maybe this is something that the goals of the client would be missed by not having it.

Justice: So why would an investor want to look further into the momentum strategy?

Rosenberg: Well ultimately looking at momentum is something that every investor probably hears about. You look at CNBC or any type of news report, and they talk about the momentum behind specific indexes or stocks that are carrying lot of momentum. So they are going to get a call maybe from a client, so it doesn't hurt to be familiar with it. But the key is to really understand what it's trying to do. Add these specific stocks which have momentum and historically that will mean securities are going to move more than the market it's looking at. By doing that, is that the type of strategy that fits in with what you are trying to do for your clients across the board?

Justice: Typically these are strategies that have pretty low correlation to each other over time that produce pretty good returns, separated?

Rosenberg: Correct. In short bursts I would say they probably have very strong returns, and momentum would be thought of something like Apple over the last few years. No matter what the market condition has been, Apple seems to have grown in terms of share price no matter what. Now, that's not always the case, but when you look at our definition of momentum, to put it plainly, we're going to look basically at a year's worth of data minus the last month and that's what we're going to use as momentum. So even though a security may have come down within the last two three weeks and it's losing its momentum, it doesn't affect the index as of yet. So that still would be included in there.

Justice: So this is a strategy that's going to have more turnover than just a basic market-cap-weighted index, but probably not as great as many people would think.

Rosenberg: Potentially yes. It's still going to have more turn over than an average index because it rebalances monthly which is always something to look for, but in the long run momentum stock tend to stay momentum for a while. It's not that they are going to just all of sudden fall out. So, a stock may stay in there a little bit longer but with monthly turnover, their weights may change depending on what's happening within the index.

Justice: Great. Well I appreciate you shedding some light on these products. Thank you for joining me.

Rosenberg: Thank you for having me.

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