Information Momentum Refined: Less Volatility, More Diversification
To offset the underperformance of value stocks, which has persisted for some time, and to smooth out the returns to our portfolios, we have attempted to strengthen our factor models. In particular, we have refined our growth-related factor category. We believe this will reduce volatility and provide greater diversification^ benefits versus the Value factor.
To do this, we moved beyond the conventional means of measuring information momentum, which is among the factors in our growth category. We believe that by expanding the information set to include data that extends beyond what is normally supplied and/or interpreted by sell-side analysts, we have created a refined Information Momentum factor that is 1) more robust, 2) less volatile and 3) more predictive than conventional growth and price momentum factors.
A Richer Information Set
Typically, information momentum is normally measured by earnings revisions and price target revisions as well as information and sentiment gleaned from earnings conference calls. In addition, conventional indicators of information momentum are typically focused on short-term events. But the incomplete explanatory power of all these indicators suggests that something else lies behind stock price performance that has not been fully measured.
At PGIM Quantitative Solutions, we believe a fuller explanation for stock performance may lie in a richer set of information, 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, this refined Information Momentum factor has improved our growth factor category, enabling it to provide better diversification benefits versus the Value factor.
To begin, we distinguish “information” from “news” While information relates to fundamentals that produce durable effects on stock prices, “news” produces price movements that are transitory. To create a more refined Information Momentum factor, we collected not only conventional analyst information (earnings estimates, revisions, target prices), but also a wide range of non-earnings data, including industry-specific metrics and data such as product launches, which have longer-term implications.
^ Diversification does not protect against a loss in a particular market; however, it allows you to spread that risk across various asset classes.
