Congratulations to Dr. Kobana Abukari and Dr. Isaac Otchere, the winners of the 2017 Annual CFA Society Toronto & Hillsdale Canadian Investment Research Award. They received this award for their paper “Dominance of Hybrid Contratum Strategies over Momentum and Contrarian Strategies: Half a Century of Evidence”. Dr. Abukari is an Assistant Professor of Finance at Laurentian University, and Dr. Isaac Otchere, a Professor of Finance at the Sprott School of Business, Carleton University. The research paper was selected from among 11 very competitive submissions made by academics from top business schools in the world and by practitioners from leading investment firms in Canada. To find out more about this award winning paper and the research that led to it, we caught up with Dr. Abukari for a few questions.
Question #1) Can you summarize the key concept of your research that led to this award for your paper "Dominance of Hybrid Contratum Strategies over Momentum and Contrarian Strategies: Half a Century of Evidence"?
Investors want their investments to perform better so they are always looking for investment strategies that will help them outperform the market. Two such investment strategies that have been widely implemented are momentum and contrarian strategies. Momentum strategies are based on the notion of return continuation; that is to say, buying stocks that have performed well in the past 3-12 months (i.e. intermediate term past winners) and selling stocks that have performed worse in the past 3-12 months (intermediate term past losers) will help investors earn abnormal returns in the next 3-12 months. On the other hand, contrarian strategies are based on the notion of return reversal; that is to say, buying past (long term) losers and selling past (long term) winners, with losers and winners ranked over 2- to 5-year periods, will lead to abnormal returns in the next 2-5 years (i.e. long term).
One of the reasons why momentum strategies are expected to work is because investors herd or trend chase. So in their desire to be part of the bandwagon, they tend to push stock prices in the same direction in the short to medium term. Contrarian strategies, on the other hand, are expected to perform better in the long term partly because investor overreaction will be corrected/reversed in the long term. We have been very impressed and fascinated by the robust performance of momentum and contrarian strategies over time and in almost every country.
However, we looked at momentum and contrarian strategies and saw the possibility of creating two new clusters of strategies (viz., contratum and momentrian investment strategies) by interacting the ranking period logic of each strategy with the holding period logic of the other. So our contratum strategies are based on the notion that buying stocks that have performed worse in the distant past (long term past losers) and selling stocks that have performed better in the distant past (long term past winners) will generate abnormal returns in the intermediate term. Momentrian strategies are based on the notion that buying stocks that have performed better in the immediate past (medium term past winners) and selling stocks that have performed worse in the immediate past (medium term past losers) will lead to the realization of abnormal returns in the long term
We hypothesized that our hybrid contratum strategies will perform better than the other three classes of strategies because in an era of significant advancements in technology and the consequent instantaneous access to information, reversals should also occur in the short or intermediate term, and not just in the long term. As a result, we expected hybrid contratum strategies which rank stocks over the long term (like contrarian strategies) but hold them over the short/medium term (like momentum strategies) to perform better.
To test this hypothesis, we used data on over 3,500 Canadian stocks from 1956 to 2015 to evaluate the performance of 16 momentum strategies, 16 contrarian strategies, 16 hybrid contratum strategies and 16 hybrid momentrian strategies.
Our results show that:
- Hybrid contratum strategies dominate momentum and contrarian strategies. The top 15 strategies are hybrid contratum strategies. Only one contrarian strategy outperformed the last hybrid contratum strategy.
- The top performing strategy, a contratum strategy ranked over 60 months and held over 3 months, earned hedged monthly return of 1.1%, compared to 0.5% for a traditional momentum strategy and 0.7% for a traditional contrarian strategy.
- A dollar investment in the hedged portfolio of losers minus winners of the contratum strategy at the beginning of the ranking period in February 1962 would have been worth $635 by the end of the common ranking period in January 2013, compared to $68 for a traditional contrarian strategy and $22 for a traditional momentum strategy.
- The performance of hybrid contratum strategies is not crowded out by documented anomalies such as the size effect, January effect, or macroeconomic factors.
Question #2) What was the initial reasoning for your project? What did you expect to find?
Our contention is that hybrid contratum strategies will perform better than other stock returns-based strategies. This contention is based on the reasoning that if we combine the documented evidence of investors’ tendency to overreact, herd, extrapolate, trend chase and/or engage in positive feedback trading with improvements in technology and the consequent instantaneous access to information, then subsequent reversal should happen in the short to medium term (3-12 months) as well and not just in the long term (2 to 5 years).
Thus, as a result of the immediacy of information availability to stock market participants, we contended that investors who have overreacted will sooner, rather than later, have confirming information that will point to their overreaction to some news event. Consequently, we expected any overreaction to be corrected sooner rather than later, and this sooner correction of the initial overreaction will, all things being equal, lead to reversals occurring in the intermediate term, which, we argue, should make hybrid contratum strategies profitable.
Question #3) What are your next research projects, and what is the focus?
My research projects will continue to focus on empirical corporate finance, investments, financial analytics, market quality, corporate governance and big data. Our next research project is to extend the current research on contratum strategies to other markets. We are planning on getting U.S. (as well as other countries’) data to examine whether contratum strategies will dominate momentum and contrarian strategies in these stock markets also.