What are we looking for?
Canadian-listed companies showing momentum in three different ways, but with low beta characteristics.
The screen
The concept of momentum investing is not a new one. At the end of the day, this style of investment capitalizes on the crowd mentality of seemingly inefficient capital markets. For any investor that has tried this route, one of the heaviest drawbacks is high portfolio turnover, particularly in volatile markets when stocks do not exhibit a solid trend in one direction. With this in mind, this week I use Morningstar CPMS to create a momentum-oriented strategy that captures three different types of momentum while still favouring companies with low beta to reduce the overall turnover and volatility of the portfolio. The strategy ranks stocks on the following seven factors:
- Absolute price change from month-end six months and 12 months ago (higher figures preferred);
- Price change relative to the sector-median price change from month-end six months and 12 months ago (higher figures preferred);
- Percentile score of the stock’s price change from month-end six months and 12 months ago against all companies in the Morningstar CPMS Canadian database, which consists of 700 companies (a score of 90, for example, would mean that the stock is in the top 10 per cent of price movers among the stocks in our database).
- Five-year historical price beta (recall the companies with a beta lower than one has historically moved less than the index in trending markets – in this case we use the S&P/TSX composite total return as our index. Here we prefer lower beta to reduce risk, and turnover).
The first six factors, respectively, track: the absolute momentum of the stock; the relative momentum of the stock against its sector peers; and the relative momentum of the stock against 700 stocks in our Canadian database.
Only the largest 200 names in Canada by market capitalization were considered for inclusion in this portfolio to account for the liquidity required to execute the above strategy.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used Morningstar CPMS to back-test this strategy from June, 1990, to December, 2017. During this process, a maximum of 25 stocks were purchased and equally weighted with no more than five stocks per economic sector. Stocks would be sold if their rank fell below the top 50 per cent of the ranked universe of 200 companies. When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 15.3 per cent while the S&P/TSX composite total return index gained 8.3 per cent. In calendar year 2017, this strategy produced 13.4 per cent while the index advanced 9.1 per cent.
It is also worthwhile to note that over the full back-test period turnover on the model was roughly 58 per cent. This is equivalent to 58 per cent of the portfolio holdings being traded each year based on historical trades, which is fairly low considering the nature of the model.
The stocks that meet our requirements for purchase today are listed in the accompanying table. As always, it is recommended that investors conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.