One of the most powerful investment management styles in the Australian share market is buying shares with momentum. According to some asset managers, the momentum factor is more powerful here than in most other markets and has been a money maker for investors over the shorter term.

Momentum strategies rely on persistent returns. If the return on a stock is positive (or negative) this month, then it is more likely to remain positive (negative) next month than to reverse. Over the past few years, and since the coronavirus pandemic, the momentum factor has delivered very strong returns, with high performing technology stocks driving much of the gains.

Peter Brooke, head of quantitative investments at Platypus Asset Management, says the momentum factor is the most powerful in the Australian share market, and much more so compared to global markets.

“It’s very strong in Australia, momentum is not as strong in the S&P 500, and that’s why you need to take account of it in Australian equity portfolios,” says Brooke.

“It’s hard to know exactly why momentum performs so differently across the world. A possible explanation is culture. We have a culture more focused on the short-term, and that feeds in to the Australian investor sentiment.”

Other possible explanations for the strong performance of the momentum factor locally include high participation of retail investors and the size of institutional investors with respect to the size of the local market.

Apart from momentum, there are other factors that drive risk and return. “Quality” strategies involve investing in companies with strong balance sheets including consistent earnings and low debt. “Value” stocks are those that have low prices relative to their financial fundamentals such as earnings.

The chart below from global index provider MSCI, which researches factors operating in share markets globally, shows that momentum is the greatest factor at work in driving share price risk and returns in Australia.

Factors: Key exposures that drive risk and return

MSCI Factor Box

Factors: Key exposures that drive risk and return

Soure: MSCI

Working a momentum strategy

Platypus’s Brooke runs a momentum fund, the Platypus Systematic Growth fund (18205). He takes the top 60 performing stocks over the past 12 months from the top ASX 300 stocks, then calculates the last 12 months performance of every stock in the index and then buys the 60 stocks that have performed the best.

“Next month, you do the same thing. Some of the 60 stocks will have changed over the month because prices will have moved. The momentum strategy involves selling those stocks that are no longer in the best performing 60 names, and buying the new stocks to replace those that are sold,” he says.

This strategy has outperformed the Australian share market, as the chart below illustrates.

Performance of momentum compared to S&P/ASX 300 accumulation index

Performance of momentum compared to S&P/ASX 300 accumulation index

Source: Platypus Asset Management

“Academic literature and our own research suggest that stock price momentum is, on average, the best performing factor in the Australian share market. As such, the Platypus Systematic Growth Fund uses a systematic approach to provide a factor tilt towards high quality momentum,” says Brooke.

“However, it is hard to implement well. This is where we come in,” says Brooke, explaining that an active manager must balance high trading turnover with the returns on buying and selling momentum stocks. Since its inception in 2009, the Platypus Systematic Growth Fund has returned 8.44 per cent a year, compared to 6.74 per cent for the S&P/ASX 300, before fees.

A note of caution comes from Ross MacMillan, manager research at Morningstar Australasia. He points out that when momentum turns, gainers can quickly become losers. Investors are asking at the moment whether the momentum has turned for technology stocks.

“Momentum is great in a bull market, but as soon as the market turns, it’s not a great place to be. At the moment, momentum is great, but at some point, it will peter out,” says MacMillan.

“The market drop in March highlights that. Stocks dropped very quickly, led by high P/E stocks. And that can have a big impact on your portfolio.

“The tech wreck of 2000 illustrates that, when technology stocks crashed hard after a very strong run.”

However, Brooke notes that the Platypus Systematic Growth Fund outperformed the ASX 300 by 1.68 per cent in March, highlighting “how hard it is to implement momentum well” and the role of active managers in refining the strategy.

Treading carefully is paramount, says AMP Capital portfolio manager Dermot Ryan. “While there are gains to be made for those who buy at the right time, weighing up your personal appetite for risk and ability to withstand loss is an important consideration.”

Investors can gain exposure to the momentum factor through a variety of investment products, including actively managed funds and exchange-traded funds with exposure to growth stocks, says Morningstar’s MacMillan.

“Certainly, if you are exposed to a growth manager then you are going to get exposure to momentum through that. The manager will hold a lot of stocks with a high price-to-earnings ratio, which have been pushed up by the momentum factor,” he says.