AIM Portfolios: Evaluating Momentum & Timing

4.12.2021

AIM Portfolios: Evaluating Momentum & Timing

Overview

Several weeks ago we covered the valuation component of the ETF Action Active Index Models (AIM) and specifically how we rate fund valuations. As a reminder, the ETF Action AIM Portfolios are scored across five primary criteria: Macroeconomic, Fundamental (Quality & Growth), Relative Valuation, Momentum, and Timing. Each component is evaluated and included in the final allocation determination made by the ETF Action Investment Committee. 

Today we focus on the momentum and timing components. Specifically we will cover what we look at when determining momentum & timing scores within a specified universe such as sectors and industries. Sections include:

  • Why Include A Momentum Component?
  • How Do We Measure Momentum?
  • Using A Timing Indicator

Why Include A Momentum Component?

Momentum is simply the continuation of an ongoing trend over a specified time period. When we refer to momentum in the marketplace it is typically in regards to a specific asset class, sector, or company showing strong positive or negative relative performance. There are a number of different investment strategies that target the momentum factor (you can screen for ETFs that target momentum using the ETF Action Classification System), all of which use their own twist on the concept and often times can come with above average bouts of volatility relative to other factors. So why use it? Put simply, because it can work. A number of academic studies have shown that this "herding mentality" factor is pervasive and effective (at times). 

In the ETF Action AIM Portfolios, we look to include market segments that are displaying positive momentum and avoid market segments that are displaying negative momentum. That being said, the momentum component falls lower on the totem poll than what we believe to be more important when evaluating potential allocation decisions: a bullish macro backdrop, strong fundamentals, and reasonable valuation levels.

 

How Do We Measure Momentum?

Multiple Time Frames Helps Identify, Confirm, and Elevate

When evaluating momentum within a particular market segment, we look at relative performance over the past twelve months to see what has maintained a positive uptrend and is also illustrating above average relative performance over shorter time frames. More specifically, we focus excess returns to a common benchmark (ie: SPY for the U.S. Sector & Industry AIM Portfolio) on 1-month, 3-month, and 12-month time frames.

Source: ETF Action

The 1-month time frame helps identify new emerging trends. The 3-month time frame provides confirmation that a new trend still exists (rather than a "flash in the pan" short-term reversal). The 12-month time frame helps elevate those segments that have remained in a longer-term uptrend with sustained support. Once we have calculated excess returns for all three time horizons for all potential investments in the universe, we use z-scores to help compare and illustrate which segments are demonstrating strong levels of positive or negative momentum.

As a reminder, z-scores are measured in standard deviations away from the mean of a data set and are not on a linear scale. For example, 68% of scores will fall within 1 standard deviation while 95% of scores will fall within 2 standard deviations meaning a score that is two standard deviations above the mean is showing strong positive momentum. The further away from the mean, the more meaningful the score.

 

Using A Timing Indicator?

We refer to timing as a very short-term indicator that helps identify positions that are potentially overbought or oversold based strictly on current price movement relative to historical price movement. When evaluating the AIM portfolios, we specifically look at the 14-day relative strength index (RSI) to help with decisions on when may be an opportune time to enter or exit positions. 14-day RSI is a momentum oscillator with scores between 0 and 100.  An RSI below 30 is considered oversold while an RSI above 70 is considered overbought. 

So for example, if the investment committee was looking to create a new position in a certain industry ETF while looking to trim off of another position, it may use a time period when the new position was at oversold levels and the position to rim was at overbought levels. Keep in mind, the 14-day RSI is the last item we look at allocation process but plays a part on when particular allocation decisions get made.

Source: ETF Action

For more information, please reach out to team@etfaction.com

 

Alex Shepard is the COO & Director of Research at ETF Action. Inquiries can be sent to alex@etfaction.com 

Important Disclosures

All ETF Action Model Portfolios are made available to subscribers for informational purposes only and do not represent actual investments. The opinons expressed herein are just that, and should not be construed as any type of investment advice. Full terms of service, including terms of use, copyrights, and disclaimers are available here.

To learn more about the ETF Action AIM Portfolios, please visit www.etfaction.com/models  or reach out to team@etfaction.com.

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