Skip to Content
ETFs

Momentum for Asset Allocation

This ETF uses offensive and defensive momentum signals for tactical asset allocation.

A version of this article was published in the February 2019 issue of Morningstar ETFInvestor. Download a complimentary copy of Morningstar ETFInvestor by visiting the website.

Momentum is one of the most pervasive forces in financial markets. It has been observed in nearly every market studied. While targeting assets with strong recent performance appears to have been a winning strategy on paper, there are challenges with putting it into practice. It requires high turnover, which can be a lot of work for do-it-yourself investors and can lead to high transaction costs and poor tax efficiency.

Cambria Global Momentum ETF GMOM takes the work and much of the costs out of momentum-driven tactical asset allocation. This strategy isn't perfect, but it is reasonable.

Strategy Overview This is an actively managed, rules-based strategy that invests exclusively in other exchange-traded funds. This structure reduces transaction costs compared with holding the underlying securities directly, as it reduces the number of trades required. It also promotes tax efficiency because the manager can leverage the ETF's in-kind redemption feature to purge low-cost-basis securities from the portfolio, reducing the likelihood of capital gains distributions. Cambria explicitly seeks to mitigate the tax impact of this strategy and may engage in tax-loss harvesting--selling losers to realize losses that can offset some of the portfolio's gains.

The investable universe is around 50 ETFs, curated by Cambria, that cut across U.S. and foreign stocks, bonds, and alternative asset classes, like commodities and currency, each representing a different segment of the market. This list is largely fixed and includes both Cambria and non-Cambria funds.

Each month, Cambria ranks ETFs within its selection universe on their relative performance to one another and targets the top third. Unfortunately, Cambria doesn't disclose how it measures relative performance. However, Mebane Faber, the firm's founder, says that the metrics it uses focus on returns and do not make any risk adjustments. To mitigate turnover, ETFs already in the portfolio remain eligible as long as they rank in the top half of the group. Funds that pass this screen are equally weighted.

This focus on relative performance represents the offensive part of the strategy, designed to deliver market-beating returns. When the stock market is doing well, the portfolio should favor stocks and riskier areas of the market over high-quality bonds. And while this signal can move the portfolio into more-defensive areas of the market during long downturns, it struggles during periods of high market volatility and when the market changes direction. For example, momentum tends to favor cyclical areas of the market at the end of a bull market, which tend to underperform in downturns, and defensive names in early recovery periods, when riskier fare is in favor.

To reduce risk, this strategy requires each fund that passes its initial relative performance screen to pass a subsequent trend-following screen. This is the defensive part of the strategy. Trend-following is a form of momentum that focuses on a security's performance relative to itself rather than against other securities. For example, a simple trend-following rule might suggest buying a fund when its current price is higher than its moving average closing price over the past 10 months, and selling it to move to cash when its price dips below that level.

The idea is that bad performance tends to cluster--bad things happen together. This could arise because investors may be slow to react to new information. Historically, most of the market's worst days have come when it has already experienced a stretch of bad performance. Cutting out those periods entirely would have historically reduced drawdowns and volatility without significantly hurting returns. So, the ETF's trend-following adjustments can help ratchet down the portfolio's risk when market risk picks up. Here, again, Cambria doesn't disclose the trend-following rule it uses, though Faber indicated it is similar to a simple moving average rule.

If a fund that passes the initial relative performance screen doesn't pass the trend-following screen, the money that would have gone into that fund goes into cash or a bond ETF instead. It's possible for the portfolio to move all its assets to cash and bond ETFs in the unlikely event that no funds pass the trend-following screen.

The composition of this portfolio can change significantly over time. For example, at the end of 2017, about 91% of its assets were invested in stocks, and it did not hold any bond ETFs. By the end of 2018, its stock allocation had fallen to 37%, as stock markets sank, and its bond allocation climbed to 48%.

Performance The best benchmark is probably the fund's sibling, Cambria Global Asset Allocation ETF GAA, which offers a long-term strategic allocation across asset classes sized to the approximate composition of the global market for risky assets. GAA doesn't just hold broad market-cap-weighted funds--it includes some value and momentum funds. Unlike GMOM, GAA doesn't use momentum to time exposure to its holdings.

So far, GMOM lagged GAA by 2.55 percentage points annually from the latter's inception in December 2014 through February 2019. During that time, it had comparable performance during market downturns and lagged in rallies. Its trend-following component was probably responsible for its underperformance during rallies. While this should help during market downturns, the fund had a heavier allocation to stocks than GAA over most of this span, which offset this protection. To put GMOM's level of risk in perspective, its market beta against Vanguard Total Stock Market ETF VTI was 0.36 from December 2014 through February 2019.

Fees Cambria charges a 0.59% management expense ratio. Its prospectus expense ratio looks higher because it includes acquired fund fees, which are the fees the underlying funds charge (currently 0.44%). That headline number changes over time with the composition of the portfolio. While it is expensive, buying this strategy is probably more cost-efficient (and almost certainly more tax-efficient) than trying to implement it on your own. That's the only close alternative.

Disclosure: Morningstar, Inc. licenses indexes to financial institutions as the tracking indexes for investable products, such as exchange-traded funds, sponsored by the financial institution. The license fee for such use is paid by the sponsoring financial institution based mainly on the total assets of the investable product. Please click here for a list of investable products that track or have tracked a Morningstar index. Neither Morningstar, Inc. nor its investment management division markets, sells, or makes any representations regarding the advisability of investing in any investable product that tracks a Morningstar index.

More on this Topic

Sponsor Center