Time Series Momentum Implemented: Testing the Performance of Long-Only Time Series Momentum Strategies from the Perspective of an Individual Investor, Accounting for Strategy Costs

Abstract

Moskowitz, Ooi, and Pedersen (2012) develop a time series momentum (TSMOM) strategy that uses the sign of an asset’s mean excess return over a lookback horizon of 12 months to determine its trend signal. The strategy takes long positions in assets with positive signals and short positions in assets producing negative signals. They find that the strategy realizes abnormal excess returns. These results do not, however, account for costs associated with strategy execution. Related studies that do account for costs, are conducted from the perspective of institutional investors. Finally, the use of shorting in the strategy may not be a viable option for some individual investors. Hence, many of the findings documented in the literature are of little practical utility to individual investors. Therefore, this paper seeks to discover the degree to which an individual investor can realize portfolio performance that outperforms traditional investment strategies, by implementing a long-only TSMOM strategy that accounts for real-life costs. For use throughout the analysis, the paper develops two long-only TSMOM strategies termed the levered TSMOM (LTSMOM) strategy and the unlevered TSMOM (UTSMOM) strategy. In both cases, when an asset has a negative trend signal it is excluded from the portfolio, rather than shorted. Moreover, the new strategies account for transaction and financing costs in the calculation of their returns. Using data from 15 equity index and 6 bond index ETFs between January 2004 and October 2019, the paper performs a pooled panel autoregression and finds significant price continuation in the data. Comparing a broad set of performance measures across strategies and lookback horizons, the paper discovers a lookback horizon of 3 months to produce the best results for both the LTSMOM and the UTSMOM strategy. Furthermore, the paper finds that using 3-month lookback horizons, the strategies outperform identically constructed strategies that do not use time-series momentum signals, emphasizing that the use of these signals enhances investment performance. Testing the impact of costs on the strategies, the paper finds that both the LTSMOM and UTSMOM strategies are robust to transaction costs. However, the paper determines that the LTSMOM strategy is unsuitable for implementation due to its significant decline in performance, caused by financing costs. The paper finds that the UTSMOM strategy is robust to expense ratio costs specific to ETFs, indicating that the asset class is suitable for use in the strategy. Finally, the paper compares the performance measures of the LTSMOM and UTSMOM strategies to two standard asset allocation strategies. The paper finds that the UTSMOM strategy exhibits a considerably higher Sharpe ratio than the other strategies and displays superior risk measures. Moreover, the UTSMOM strategy realizes a statistically significant alpha, presenting a challenge to standard rational asset pricing theory