Risk taken by asset managers can be assessed in a number of ways. Comparing a manager’s portfolio beta to that of their relevant index is a longstanding first step in considering how risky a collection of stocks may be. More sophisticated risk assessments include a review of component factors that explain systematic risks. Unfortunately, neither of these methods serves a useful purpose when evaluating momentum portfolios. A 2012 study by Barroso and Santa-Clara shows that beta explains only 23% of the risk for momentum stocks. Most of the risk for momentum stocks is specific risk. Second, since momentum styles actively choose to over-index the momentum factor, factor risk assessments serve to confirm at least one known and intentional factor risk, making that indicator useful only in a relative or historical context. What risk measure makes sense?
- It’s not beta.
- It’s not factor exposure.
- It’s not risk/expected return.