Following the success of diversifying Growth insights in the US, we broadened our research exploration of the Information Momentum factor, extending it to global universes.
- Using additional data sources and a broader set of information events has led to consistent and notable improvement in coverage across all major indexes and across sectors.
- Information Momentum captures a broader set of Growth insights and allows for greater portfolio stability.
- Information Momentum shows lower performance volatility and lower drawdowns compared to Price Momentum and much lower decay than Estimate Revisions.
To reduce portfolio volatility and provide greater diversification relative to the Value factor, we refined the input set and introduced a new Growth factor called Information Momentum into our US strategies in 2021 (see Information Momentum Refined: Less Volatility, More Diversification). We expanded beyond earnings-related information, near-term fundamentals and measures that rely on sell-side analysts, to include a wide range of data, such as industry-specific metrics, which have longer-term implications. The result was a refined Information Momentum factor that is negatively correlated with our Value factor and is more robust, less volatile and a more powerful predictor of stock prices than typical Growth factors.
The motivation for refining the factor was to introduce incremental Growth insights utilizing different techniques and data sources. The intention was to produce a factor that captured Growth insights but that was more ‘stable,’ allowing portfolios to have greater Growth exposure without increased turnover. Given the encouraging results of the factor since its introduction, we broadened our research exploration of the factor across the EAFE and Emerging Markets universes.
Recap of Information Momentum
At PGIM Quantitative Solutions we quantify Growth via fundamental information (see News, Not Trading Volume, Builds Momentum and Price Momentum or Information Momentum). Stock prices are driven by revisions in earnings multiples and in fundamentals (expectations), which change as new information becomes available. Information-driven price behavior helps avoid ‘crash risks’ associated with multiple expansion (and what impacts performance of traditional Price Momentum measures). As such we can capture the ‘good’ momentum without the heightened risk.
There are several approaches to measuring new fundamental information: earnings revisions and price target revisions as well as information and sentiment gleaned from earnings conference calls.
However, a limitation of these conventional indicators is that they are typically focused on short-term events. For example, revisions to 12-month EPS capture information relevant to only the next 12 months. The incomplete explanatory power of these conventional Growth indicators suggests that something else lies behind stock price performance that has not been fully measured.
We believe a more thorough explanation for stock performance may lie in a richer set of information events, specifically, information found outside of conference calls and sell-side analysts’ interpretations of revisions to earnings and price targets. By extending beyond earnings-related information, near-term fundamentals and measures that rely on sell-side analysts, we’ve refined the Information Momentum factor and improved our Growth factor category, leading to better diversification within our alpha model.