At first glance, value and momentum investing may seem like opposing approaches. Value strategies focus on identifying investments that appear undervalued based on fundamentals, while momentum strategies emphasize securities showing strong recent performance trends. However, it is because these factors behave differently that they can complement one another within a diversified portfolio.
Understanding Their Different Market Behaviours
Value investing seeks companies trading below what may be considered their intrinsic worth, based on measures such as earnings, book value, or cash flow. This approach is often viewed as similar to contrarian investing — buying undervalued securities and waiting for the market to recognize their potential value — because both strategies involve going against prevailing market sentiment.
Momentum investing, on the other hand, is typically guided by market trends rather than company fundamentals. It seeks to benefit from the tendency of securities with recent positive performance to continue that trend in the near term, while those that have lagged may continue to underperform.
Academic research, including work by Fama and French, has found that value and momentum factors have historically exhibited low or even negative correlation. This suggests that when one factor experiences challenges, the other may behave differently — potentially helping to smooth overall portfolio results over time.
How Combining Value and Momentum Can Support Risk Management
Integrating both value and momentum exposure within a portfolio may enhance diversification by drawing on distinct sources of potential return and risk characteristics:
- Complementary timing: Value strategies may offer resilience when markets correct, while momentum strategies may capture returns during extended uptrends.
- Behavioural balance: Value investing may counteract investor over-optimism by emphasizing fundamentals, whereas momentum investing may capture market trends influenced by behavioural dynamics.
- Diversification benefits: Because the two factors tend to respond differently to changing conditions, their combination may help reduce overall portfolio volatility and hopefully contribute to a more consistent long-term profile.
Applying Factor-Based Approaches in Practice
Value and momentum are two well-established factors within modern portfolio theory. Their distinct market behaviours and historically low correlation have the potential to make them useful components of a diversified, risk-managed approach.
Some index-based investment strategies apply systematic factor screens to adjust exposures across different market environments. For example, the CI U.S. Enhanced Momentum Index ETF uses a defined momentum methodology to provide exposure to U.S. equities demonstrating positive price trends.
By understanding how value and momentum interact, some investors may better appreciate how disciplined, factor-based strategies seek to balance risk and return through changing market environments.
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