Momentum is a share market factor strategy that involves investing in stocks that have exhibited strong price growth over the past 12 months. On the surface, it sounds logical – buy stocks that have been performing well. However, as with many ideas that appear compelling in theory, the reality is more nuanced. Momentum investing often fails to deliver superior long-term returns once costs and taxes are considered.
So, what lessons can investors draw from this?
What is factor investing?
Factor investing in share markets uses a systematic, often rules-based approach to select stocks within an index that share certain measurable characteristics. These characteristics, known as factors, are chosen because historical evidence shows they help explain differences in risk and return over time.
By tilting a portfolio towards these factors, investors aim to achieve either higher returns and/or lower risk compared to the traditional market cap index.
Two of the most widely recognised and used factors are Value and Quality.
The Value factor targets companies that appear attractively priced relative to their fundamentals. Put simply, value-focused strategies avoid stocks that are overvalued based on ratios such as price-earnings and price-book values. The rationale is straightforward: the price you pay for an investment largely influences your future returns. Paying too much for an asset usually leads to below-average returns.
The Quality factor focuses on investing in financially robust businesses. These are typically companies with strong balance sheets (low debt), high returns on equity, and reliable, stable cash flow and earnings. The underlying thesis is that higher-quality companies tend to be more resilient. They are better able to withstand market downturns and deliver consistent long-term performance.
We use both factors in our personal and client portfolios.
What attributes should a factor possess?
There are many recognised investment factors beyond Value and Quality. However, the reality is that some are more marketing puffery than genuine investment strategies. To be considered investment-grade, a factor must meet several key criteria:
- Rooted in fundamentals and logic: The factor must make economic sense. It’s not enough to show a statistical correlation – there needs to be a clear, logical explanation of why the characteristic produces a positive (or negative) result.
- Observed across all markets: A robust factor can be identified across all developed share markets, not just in one or two. This consistency suggests the relationship reflects a universal investment principle.
- Persistent over many decades and cycles: There must be long-term evidence of the factor delivering results over multiple decades and through various market conditions.
- Robust to reasonable definitions: If a strategy still works when slightly adjusting its parameters, for example, selecting stocks with a P/E ratio below 20 instead of below 18, it indicates the factor reflects a general phenomenon rather than a cherry-picked formula.
- Implementable (track record): Investors must be able to access the factor without excessive trading costs, management fees, or tax drag eroding the expected return benefit. It needs to have a track record – history of actual returns.
Only factors that meet all these criteria can be considered truly investment-grade.
What is the monument factor?
The Momentum factor is based on the observation that stocks which have been rising in price tend to continue rising, at least for a while. The theory is that investors are often slow to fully absorb new information, causing prices to drift upward as the news gradually sinks in. In addition, human behaviour amplifies this trend: fear of missing out (FOMO) and herd mentality often drive investors to chase recent winners. Bitcoin is an excellent example of this.
A typical momentum strategy involves ranking all stocks within an index by their 6-12-month total return, from highest to lowest. The most recent month is usually excluded because prices often experience a short-term reversal or “bounce” following a strong run. For instance, if conducting this analysis at the start of October, you would look at returns for the 12 months to 31 August 2025. The portfolio would then consist of the top 10% to 25% of the highest returning stocks.
Momentum investors generally hold these stocks for around six to twelve months, the period during which momentum tends to persist. However, the strategy requires regular rebalancing: each 1-3 months, the portfolio must be reviewed, new top-performing stocks added, and those that have lost momentum sold.
Given how fast global stock markets, gold, bitcoin, etc. are moving, I thought now is a good time to revisit a momentum strategy – essentially, buying what’s currently popular.
What does the real-world evidence tell us?
In theory, the Momentum factor sounds compelling. However, real-world results tell a different story. Over time, momentum strategies have generally failed to produce higher returns than simple market-cap-weighted indexes. Academic research confirms that, once transaction costs and taxes are considered, the performance advantage largely disappears.
The main reasons momentum strategies struggle to deliver outperformance are:
- Trading costs: Momentum strategies typically involve high portfolio turnover. Frequent buying and selling generate trading costs such as bid–ask spreads, market impact, execution delays, and brokerage fees. These costs are particularly pronounced when trading in less liquid stocks. Funds that attempt to reduce turnover to keep costs low usually dilute the strength of the momentum factor, undermining the strategy’s effectiveness.
- Taxation: If the strategy is lucky enough to be profitable, the high turnover also leads to greater tax drag. Regularly realising short-term capital gains makes the strategy inherently tax-inefficient, especially for individual investors.
For example, the most popular momentum ETF in the US is iShares MSCI USA Momentum Factor, with almost $30 billion under management, has underperformed the broad market index by about 1% p.a. over the past decade.
In Australia, Betashares launched an Australian market momentum ETF in July 2024. Over its most recent 12 months, it outperformed the ASX 200 by an impressive 7%. However, one year is far too short a period to draw meaningful conclusions. Time will tell whether this early success is sustainable or simply the result of short-term market dynamics.
Does a momentum strategy work with property?
Plenty of buyer’s agents on social media like to highlight short-term success stories. For example, “I bought this property for a client three years ago and it’s now worth 50% more.” That’s certainly a great outcome for the investor, but it does not necessarily mean they will be successful property investors over the long-term.
If transaction costs erode a momentum strategy in the share market, you can be certain they have an even greater impact on property returns, given how much higher entry and exit costs are. A strategy built on buying in locations expected to “boom”, then selling and reinvesting after a short period (say, five to seven years), is almost always inefficient, and therefore, ultimately unsuccessful. It’s also a higher risk strategy as you need to be consistently accurate with your timing and property selection.
The key to property investing is to maximise capital growth over decades, not years. The goal is to own investment-grade assets that possess the attributes to deliver the strongest average annual return over 10, 20, or 30 years. That long-term compounding effect is what truly builds wealth through property. Therefore, sound fundamentals, not recent momentum is the most important factor.
Two take aways from this blog
Firstly, be careful and discerning with factor investing in share markets. You need to be highly selective about which factors you use, which fund managers you trust to implement them, when you invest, and in which geographical markets. An ETF manager’s job is to tell a compelling story, but your job is to ensure that the factor itself is fundamentally sound and backed by solid evidence, not marketing spin.
Secondly, when it comes to property, don’t be dazzled by recent returns. In my research earlier this year, I highlighted that residential property growth cycles typically last around 10 years. Therefore, the ideal time to buy (an investment-grade property) is before a new growth cycle begins, or within the first year or two of that cycle. That’s when you’re most likely to capture strong early returns. By definition, this means the market you are entering will usually have just come out of a flat period, with recent growth well below average, and that’s a good sign. Conversely, investing in a market that has already performed strongly over the past five years might feel reassuring, but in reality, it often carries higher risk and lower prospective returns.
