Why Monthly Rebalancing is Key to Unlocking the Power of Momentum Investing

Why Monthly Rebalancing is Key to Unlocking the Power of Momentum Investing

Momentum investing has long been one of the most robust and persistent factors in financial markets. Decades of academic research show that stocks with strong recent performance and improving fundamentals often continue to outperform, at least for a period of time. But while the concept of momentum is straightforward, how investors implement it makes all the difference.

At Validea, we’ve tracked the performance of three momentum strategies: our Momentum Investor (since 2003), the Twin Momentum Investor (since late 2008) and the Quantitative Momentum Investor (since 2005). These strategies identify stocks with strong momentum characteristics – based on earnings growth, price strength, and industry leadership – and build concentrated portfolios around them. These strategies are extracted from public sources, such as an academic paper, in the case of Twin Momentum, or from books, which is the case for the Momentum and Quantitative Momentum Investor models.

But here’s the key insight: the frequency of rebalancing dramatically impacts returns.

What Goes Into These Momentum Models

Before we get to the results, let’s quickly review what goes into each of these models. As you will see, each of these models are systematic and incorporate momentum drivers that are key inputs to each approach. For example:

  • Momentum Investor looks for stocks with strong EPS growth (quarterly and annual), price performance near 52-week highs, rising relative strength vs. the S&P 500, high ROE, declining debt, and leadership within top-performing industries.
  • Twin Momentum takes it a step further, requiring stocks to rank highly on both fundamental momentum (earnings, ROE, profitability, payout ratios) and price momentum (12-month performance excluding the last month). The strategy selects only the top 5% of stocks that meet both hurdles.
  • The Quantitative Momentum Investor applies the framework outline in the book, Quantitative Investor (Gray & Vogel) by first defining a liquid universe of mid- and large-cap stocks. It then ranks companies on 12-1 price momentum (12-month performance excluding the most recent month) and adds a return consistency filter, favoring stocks that rise steadily with fewer negative days. The strategy selects the top decile of stocks on momentum, further refined by this consistency screen.

The common thread is that each approach seeks to capture companies where momentum is strongest – whether it comes from fundamentals, price, or both – and monthly rebalancing ensures the portfolio is always filled with the market’s most powerful momentum names.

The Evidence: Monthly vs. Quarterly and Annual

Let’s start with the Momentum Investor strategy:

  • Monthly Rebalancing (10-stock portfolio): +1,220.7% since 2003, outperforming the market by 658.0%.
  • Quarterly Rebalancing: +442.5%, underperforming the market by 120.2%.
  • Annual Rebalancing: +963.7%, outperforming by 401.0%.

The difference is stark – monthly rebalancing has generated almost 3x the return of quarterly rebalancing and delivered far more consistent outperformance.

The same holds for the Twin Momentum strategy, which combines fundamental momentum (earnings quality, profitability, payout ratios) with price momentum (12-month performance excluding the most recent month):

  • Monthly: +2,105.8%, outperforming by 1,451.0%.
  • Quarterly: +1,417.8%, outperforming by 726.0%.
  • Annual: +1,327.3%, outperforming by 678.0%.

Same for Quantitative Momentum Investor strategy as well:

  • Monthly: +1,001.6%, outperforming by 573.9%.
  • Quarterly: +264.8%, underperforming by 148.4%.
  • Annual: +314.0%, underperforming by 118.9%.

Across all three, a monthly rebalancing approach delivers the strongest returns by a wide margin.

Why Does Monthly Rebalancing Work Better?

From a behavioral standpoint, the advantage of monthly rebalancing comes down to how momentum operates in real markets – and how investors react to changing conditions:

Momentum is Fleeting
Momentum is often driven by news flow, earnings surprises, and investor sentiment. These catalysts can fade quickly. By rebalancing monthly, portfolios stay aligned with the freshest signals and avoid holding onto fading winners for too long.

Investor Overreaction and Underreaction
Investors tend to underreact to good news in the short run (causing gradual upward price drift), but also overreact in the longer run (leading to reversals). Monthly rebalancing captures stocks in the sweet spot—where positive momentum persists – while limiting exposure to the eventual reversion.

Behavioral Anchoring and Loss Aversion
Without frequent rebalancing, investors may hold laggards too long, anchored to past performance or reluctant to realize losses. Monthly discipline enforces a systematic reset, ensuring losers are removed quickly and capital is recycled into stronger opportunities.

Industry Rotation Happens Fast
Leadership in markets rotates rapidly – from tech to energy, from large-cap growth to small-cap cyclicals. A quarterly or annual rebalance risks missing entire momentum shifts. Monthly updates allow the strategy to stay aligned with where capital is flowing today.

The Takeaway

Momentum investing work – but only if you respect its short-lived nature. The data is clear: monthly rebalancing significantly enhances returns compared to quarterly or annual updates.

From a behavioral perspective, it makes sense. Markets move fast, investors over- and underreact, and leadership rotates constantly. By rebalancing monthly, you harness momentum when it’s strongest and avoid the traps of holding stale positions.

For investors and advisors looking to capture the power of momentum, the lesson is simple: discipline and frequency matter as much as the model itself.

Further Research

Want to dig deeper into momentum investing and see how these strategies apply to today’s market? Explore these Validea tools and resources:

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