Investors face two particular challenges in capturing Momentum and Value returns.

• High costs associated with traditional active management
• Cyclicality of Momentum and Value returns

High Costs of Active Management

Traditional active management has, until recently, been the only option for capturing Momentum and Value characteristics-based returns. No internally-consistent family of global Momentum and Value indices, which could provide a passive alternative, existed in the marketplace. Active managers commonly select these stock characteristics in an attempt to outperform their benchmarks. For example, Grinblatt et al. (1995) report that value managers have a significant value exposure, while the so-called growth-oriented managers are essentially momentum players. Studies also document that a significant portion of “gross” returns in excess of the market generated by actively managed funds emanates from exposure to these stock characteristics [e.g., Carhart (1997), Daniel et al. (1997), Chan et al. (2000), Wermers (2000), and Ang et al. (2009)]. However, investors do not realize these characteristics-based returns, on average, because of high total expense ratios associated with active management [e.g., Carhart (1997) and Wermers (2000)].

Cyclicality of Momentum and Value Returns

While Momentum and Value characteristics generate meaningful market outperformance in the long run, they also depict significant independent cyclicality of returns over shorter time periods. Momentum and Value stocks independently can underperform the market by a significant margin, and often do. Periods of pronounced market underperformance tend to make it difficult for investors to maintain the long-term commitment needed to realize the full extent of these characteristics-based returns. This problem becomes more pronounced when active management is employed to capture characteristics-linked returns. As a result, investors often bail out, potentially at exactly the wrong time.

What can be done to help investors realize the full extent of Momentum and Value characteristics-based returns? Any solution should effectively address the two challenges mentioned above. That is, it should be:

• Cost-effective so that investors, and not active managers, realize the benefits of Momentum and Value investing. The management fees and other expenses charged should be a relatively small proportion of the expected market outperformance.
• Based on an investment strategy that is specifically designed to limit the magnitude of short-term underperformance, but without sacrificing long-term return generation potential, so that investors’ ability to “stay the course” can be enhanced.

NEXT» Introducing ActiveBeta^® Strategies!