Value vs. Momentum – Does One Style Contradict the Other?

Value vs. Momentum – Does One Style Contradict the Other?  

Value-based and momentum-based investing strategies are often seen as opposing approaches. However, they do not inherently contradict each other. Instead, they represent different methodologies for identifying investments, each with its unique strengths. This article examines momentum and value strategies and explores how they can coexist and complement one another, ultimately enhancing portfolio performance. 

Momentum-Based Investing: Riding the Trend 

Momentum strategies focus on stocks that have been winners in the past. They leverage the characteristic that assets which have recently delivered high returns in comparison to others are more likely to continue achieving high returns in the future. For example, stocks that have performed particularly well in the recent past tend to maintain their leading position. Multiple academic studies have demonstrated this phenomenon across various asset classes and time periods. 

According to this strategy, momentum investors prioritize stocks with the strongest performance, expecting their winning streak to continue. True to the motto, “The trend is your friend.” While researchers find it difficult to pinpoint exactly why this phenomenon has performed consistently over time, the most likely explanations stem from behavioral economics, such as herd mentality and overreaction. However, like every investment approach, momentum strategies also carry risks, such as sudden market corrections, which can erode profits if the approach is not sufficiently dynamic to adapt. 

Value-Based Investing: Seeking Undervalued Opportunities 

Value investing is built on the principle that markets are not always efficient and can misprice securities relative to their intrinsic value. Proponents of this strategy aim to identify opportunities where an asset is undervalued and offers potential for long-term gains once the market corrects its valuation. These investors focus on fundamentals, such as earnings, book value, or cash flows, to determine a stock’s fair value. 

The essence of value investing lies in patience and discipline. Investors often select stocks from overlooked or out-of-favor sectors, anticipating that their true worth will be recognized over time. This contrarian approach reflects a belief in the eventual efficiency of markets and the ability to profit from its short-term inefficiencies. However, value investing is not without its challenges. Periods of prolonged underperformance, where undervalued stocks remain stagnant, can test an investor’s conviction. Yet, for those who stay the course, the strategy has historically demonstrated resilience, particularly during market recoveries or corrections. 

Synergies Between Value and Momentum

1. Diversification of Return Drivers: 

Value investing focuses on undervalued stocks, while momentum targets high-performing ones. Combining these strategies diversifies return sources, potentially leading to more consistent performance across different market conditions. Research by Asness, Moskowitz, and Pedersen (2013) highlights consistent return premia for both value and momentum strategies across markets and asset classes. 

2. Risk Reduction through Negative Correlation: 

Value and momentum strategies often exhibit negative correlation, meaning they tend to perform well at different times. This relationship can reduce overall portfolio risk when combined. Blitz (2022) demonstrated that combining value and momentum factors leads to lower risks due to their complementary relationship. 

3. Enhanced Risk-Adjusted Returns: 

Empirical studies show that portfolios combining value and momentum strategies achieve higher risk-adjusted returns than those using either strategy alone. A study on the Australian market for example showed that a combined approach generated four times higher cumulative monthly returns than individual value or momentum portfolios. 

4. Broad Applicability Across Markets: 

The complementary benefits of combining value and momentum have been observed in various markets around the globe. For instance, studies in the Japanese stock market have highlighted the effectiveness of integrating these approaches, demonstrating superior returns compared to standalone value or momentum portfolios. Similarly, research in Sweden has shown distinguishable gains for combined strategies, with both momentum and value contributing to enhanced performance. 

Conclusion 

Value-based and momentum-based investing strategies each offer unique pathways to investing. While their contrasting philosophies and methods may suggest conflict, they are far from contradictory. Instead, their synergy reflects different aspects of market behavior—one focusing on fundamentals and intrinsic value, the other on price trends and behavioral patterns. 

By combining value and momentum, investors can build a balanced portfolio that capitalizes on undervalued opportunities while benefiting from prevailing market trends. At NDT Capital Partners, we develop robust and rule-based investment strategies with clear principles for long-term growth. If you’re interested in learning how these approaches could enhance your portfolio, we’d be delighted to discuss further. 

Sources: 

Asness, C. S. (2011). Momentum in Japan: The Exception that Proves the Rule. SSRN Electronic Journal. https://www.aqr.com/Insights/Research/Journal-Article/Momentum-in-Japan-The-Exception-that-Proves-the-Rule

Asness, C., Moskowitz, T., & Pedersen, L. H. (2013). Value and Momentum Everywhere. The Journal of Finance, 68(3), 929–985. https://doi.org/10.1111/jofi.12021

Blitz, D. (2022). Factor investing: The best is yet to come. The Journal of Portfolio Management, 49(2), 10–18. https://doi.org/10.3905/jpm.2022.1.445

Lindberg, M., & Jansson, S. (2019). Value vs. Momentum: Synergy on the Swedish Stock Market. Diva Portal. https://www.diva-portal.org/smash/get/diva2:1330289/FULLTEXT01

Savolainen, M. (2023). Momentum and Value Strategies in the Nordic Stock Markets: A Combined Approach. LUT University Publications. https://lutpub.lut.fi/bitstream/handle/10024/167780/Master%27s_Thesis_Savolainen_Mika.pdf?sequence=1&isAllowed=y

Jegadeesh, N., & Titman, S. (2023). Momentum: Evidence and Insights 30 Years Late. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.4602426