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A Fund for Greed and Fear

Alex Bryan, CFA

Alex Bryan: Momentum is based on the premise that assets that have recently outperformed will continue to do so in the short term, and that those that have recently lagged will continue to underperform. It may occur because investors may underreact to new information and pile in to a trade after a trend has been established. This phenomenon has been observed in most markets studied and over most time horizons. And it has tended to work well when value investing hasn't and vice versa. As a result, value-oriented investors may capture good diversification benefits by adding a momentum strategy to their portfolios.

AQR Momentum offers one of the best ways to take advantage of this phenomenon. It targets the one third of the U.S. large-cap market with the best performance over the most recent year, excluding the most recent month, and that's consistent with the way the academic researchers have measured momentum. It also weights its holdings using a combination of market capitalization and relative momentum, and that tilts the portfolio toward the growth side of the Morningstar Style Box but also causes the fund to overweight some of the smaller names relative to its peers.

Now, trading momentum can be an expensive proposition. In order to manage these costs, AQR Momentum explicitly balances the transaction cost of trading each stock against its relative momentum, and this approach can help improve cost efficiency.

Like any investment style, momentum can underperform for years. In fact, the strategy had one of its worst periods of performance in the wake of the 2008 financial crisis. There is also a risk that the strategy could become less effective as more investors try to exploit it. However, as long as investors are swayed by emotions like fear and greed, there is a good chance that momentum will persist, and AQR Momentum offers one of the best ways to profit from it.