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Financial Markets and Portfolio Management

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24-08-2020

Dominance of hybrid contratum strategies over momentum and contrarian strategies: half a century of evidence

Authors: Kobana Abukari, Isaac Otchere

Published in: Financial Markets and Portfolio Management | Issue 4/2020

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Abstract

The possibility of combining the ranking period logic of contrarian (momentum) strategies with the holding period logic of momentum (contrarian) strategies to form hybrid strategies motivates us to evaluate several investment strategies using data on over 2500 stocks from 1956 to 2015. We find that hybrid strategies ranked like contrarian strategies over the long term but held like momentum strategies over the medium term, which we call contratum strategies, outperform momentum and contrarian strategies. A contratum strategy ranked over 60 months and held over 3 months earns a significant monthly hedged return of about 0.7%, compared to standard momentum and contrarian strategies’ respective returns of about 0.6% and 0.4%. We subject our results to several robustness tests and find that the performance of the strategies is not crowded out by other anomalies (e.g., the size effect, January effect), risk, liquidity, volatility or macroeconomic factors.

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Momentum, which has been reported to have spilled over from stocks to bonds (Haesen et al. 2017), has also been documented in other asset classes such as commodities (Bianchi et al. 2015; Paschke et al. 2020) and currencies (Eriksen 2019). Pitkäjärvi et al. (2020) also find momentum as a cross-asset phenomenon in bond and equity markets, with past bond market returns predicting future equity market returns and vice versa.

Some risk-based explanations consider momentum and/or contrarian returns as being compensation for risk (e.g., Karolyi and Kho 2004; Lesmond et al. 2004), as reflecting cross-sectional variation in expected returns (e.g., Conrad and Kaul 1998) and as being proxies for macroeconomic factors (e.g., Chordia and Shivakumar 2002). Some behavioral explanations of the anomalies include underreaction (e.g., Barberis et al. 1998; Hong and Stein 1999) and overreaction (e.g., De Long et al. 1990; Daniel et al. 1998). Momentum and contrarian strategies have also been explained as phantom profits caused by data related issues such as survivorship bias (e.g., Boynton and Oppenheimer 2006) and data snooping (e.g., Fama and French 1996).

See http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.

See http://expertise.hec.ca/professorship_information_financiere_strategique/fama–french-canadian-factors/.

Other studies use the monthly cumulative returns approach, which assumes monthly rebalancing but Conrad and Kaul (1993) show that the approach is biased upward.

Following the standard practice in the literature, our strategies that rank stocks based on returns from 3 to 12 months skip a month between the ranking period and holding period while strategies that rank stocks based on returns of the past 24 to 60 months skip a year between the ranking period and holding period.

When the strategies are represented this way, the first number is the number of months over which the strategy is ranked, the second number is the number of months skipped and the third number is the number of months that the strategy is held for. With the 60 × 12 × 3 contratum strategy, for example, the 60 indicates that the stocks are ranked using their past 60 months’ returns, the 12 signifies the skipping of 12 months and the 3 indicates that they are held for 3 months thereafter.

Following Cooper et al. (2004), we define an UP (DOWN) market as when the lagged 3-year S&P/TSX composite index return is nonnegative (negative).

As expected, the market return variable is significantly positive in all the regressions, while market capitalization is largely significantly negative. The January dummy is significantly positively related to only 1-month future returns but negatively related to 9-month and 12-month future returns in regression model 1 but insignificantly related to future returns in regression model 2. Market state is largely significantly negative. Beta is negatively related to future returns in two instances and insignificantly negative in the remaining instances. In the few instances that they are significant, both the T-Bill return and term spread (the macroeconomic variables) are positively related to future returns.

It is worth noting that we are only comparing contratum strategies to momentum and contrarian strategies. Although our results show the dominance of contratum strategies over momentum and contrarian strategies, it is possible that other strategies or combination of strategies outside the ones that we have examined may perform better than contratum strategies.

Francoeur discontinued updating the Canadian factors at the end of 2009 so our regressions using the Canadian factors cover the 1990–2009 period.

Conrad and Kaul (1998) argue that the strategies select stocks with higher cross-sectional returns for the long position and stocks with lower cross-sectional returns for the short position.

Turnover, standard deviation, beta and double sorts on size (market capitalization) and returns do not crowd out the excess returns to contratum and contrarian portfolios.

Also, although we skip a year between the ranking period and investment period in tracking the performance of the contratum and contrarian strategies, we additionally track their performance without skipping a year between portfolio ranking and formation and the returns to the strategies again monotonically increase from month 1 to month 60.

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Title: Dominance of hybrid contratum strategies over momentum and contrarian strategies: half a century of evidence
Authors: Kobana Abukari
Isaac Otchere
Publication date: 24-08-2020
Publisher: Springer US
Published in: Financial Markets and Portfolio Management / Issue 4/2020
Print ISSN: 1934-4554
Electronic ISSN: 2373-8529
DOI: https://doi.org/10.1007/s11408-020-00363-3

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