Hi all - long time lurker, not a prolific poster. I've followed this thread with interest given that I have some experience in this field. I have a few thoughts about active investing in general (not just dual momentum) and this seemed to be the current thread to have that discussion. My apologies in advance for the dense post - had a lot of thoughts over the past few weeks to get out.
First there are several identified market anomalies that do return more than a standard market index (S&P500, Total Market, what ever). These have been identified, studied and acknowledged through mountains of academic research. Two of those anomalies are value and momentum. These were first widely identified by fama and french (ironically enough the fathers of efficient market theory). Of course, the outstanding question is do these anomalies really return more on a risk adjusted basis (i.e. do you get more overall gain due to risk) but it depends on how you measure risk. Modern portfolio theory will measure volatility and standard deviation and declare that value and momentum do not beat the market on a risk-adjusted basis. Value investors will say that's a crazy way to measure risk (risk being more identified with "overpaying" for a security and a "margin of safety" from Ben Graham). Regardless it is not difficult at all to construct portfolios that exploit value or momentum (as dual momentum does) to reliably return absolute gains greater than any market index over long periods of time. I can give you three value methods off the top of my head that do so.
The question is then "If it is easy and provable to build a system based on value and momentum that returns absolute gains greater than the market, why doesn't everyone beat the market?"
First let's discuss index buy and hold approaches. First, if you believe in a strong efficient market theory (i.e. the market price is never wrong) then buy and hold is not only smart, it's literally the only approach that makes sense. You receive the average market return and assume the average market risk which is the best you can ever do. Even if you don't believe in totally strong efficient market, buy and hold could still make sense as you may be happy with receiving the mean return at the mean risk with very little work or stress.
But if you believe, as I do and as I believe research has shown, that there are at least two anomalies that return more than the market in value and momentum why is it so hard to take advantage of?
1. Behavioral bias errors
2. Frictional costs (especially in taxable accounts)
Behavioral bias errors refer to the fact that, as humans, we are incredibly poor at making informed decisions. Our decision making process is heuristic and pattern based and is incredibly fast. It had to be in order to survive through millions of years of evolution. Unfortunately that process also makes us extremely bad at making decisions that require non emotional thinking and we often fool ourselves by seeing patterns where none exist (thanks brain!). Joel Greenblatt (of MFI fame) did a 10 year study where he found that investors systematically avoid stocks with large returns and panic and sell during down turns at exactly the wrong times - repeatedly. Unless you can be extremely disciplined you can not make active investing work. Even knowing that Value approaches beat the index - can you ride a 50% drawdown or 30% standard deviation for 15 years? Because that's exactly what it takes. Most retail investors can't. Professionals have a short time bias problem due to having to keep their jobs and so they can't. In general people actively destroy any excess returns (and them some) through these errors.
Frictional costs are also a HUGE problem. Most of the value or momentum strategies that generate the large excess returns over the market (think 20% per anum) require trading at intervals of less than 1 year. Even putting aside the transaction costs for each trade the difference between the long term cap gains and the short term cap gains is enormous. If you assume a long term cap gain tax of 23.8% and a short term of 36.8 - 42.8% (the top two highest tax brackets) then the following is true: Assuming a market return of 8% per year you would have to earn 14% just to break even on the taxes (assuming that you continued to hold the index and didn't willy nillly sell). So you not only have to beat the market, you have to beat the market by 75% to just break even if your strategy causes you to incur short term capital gains!!! Also, the short term capital gains hits are compounded right along with your gains meaning over a 15 year period the difference in long term taxes and short term taxes can literally be 1000s of percents if you don't make at least that 75% premium to break even. This is extremely hard.
My personal opinion is this is why Warren Buffet is so successful. He buys using a value strategy (known anomaly to market returns) but then NEVER sells reducing not only his taxes but completely eliminating all behavioral bias errors. He doesn't mess up because he refuses to play the game.
Ok - so enough is enough. What does this all mean. Can dual momentum beat the a buy and hold index. Yes it certainly can. IF you (a) are a super iron man on discipline and never make behavioral mistakes and (b) find a momentum system that either only makes long term capital trades or beats the market by WIDE margin to make up the difference.
I think you'll find the reality of actually executing A and B very hard in real life, which is why for almost everyone a buy and hold index strategy will far and away be the superior choice. I would say just my 2 cents, but this post has to be way more than that. Sorry for the rambling and thanks for reading.