Sheridan Titman On His Seminal Paper on Momentum Investing and What He Has Learned Since

Episode Summary

Executive Summary: Sheridan Titman discussed his seminal momentum research, arguing that momentum reflects market underreaction and is best measured by a 6- or 12-1 style window that skips the most recent month to avoid short-term reversals. He emphasized momentum’s behavioral roots, its decline after 2000 as more investors arbitraged it, the complementary role of value, and surprising findings that location and innovation clusters strongly shape firm value and returns.

Main Topics: Seminal momentum research and market efficiency (Priority: 5/5): Titman explains that momentum was an obvious test of market efficiency because underreaction should produce continuation and overreaction should produce reversals. His 1993 paper systematically tested many formation and holding periods and found statistically significant excess returns. Best way to measure momentum (Priority: 5/5): He describes the six-month formation/holding framework and the importance of skipping the most recent month because of short-term reversal effects. This supports the practical 12-1 momentum convention used by investors today. Why momentum works: behavioral vs. rational explanations (Priority: 5/5): Titman strongly favors a behavioral explanation, especially investor overconfidence and underreaction, while discounting rational risk-based stories as less convincing. Momentum’s performance over time and across markets (Priority: 4/5): He argues momentum weakened after 2000 as more institutional investors incorporated it, but notes it still behaves differently across countries. It has historically worked best in the U.S. and U.K., and differently in Japan and China depending on market structure and liquidity. Combining momentum with value (Priority: 4/5): Titman says value and momentum are complementary because they are not highly correlated. He argues combining them in one portfolio is more efficient than holding separate factor portfolios. Location, innovation, and firm value (Priority: 4/5): He discusses research showing that geography matters for firm value creation, with a disproportionate share of value coming from a small number of cities, especially for new firms and IPOs. He also links disruptive periods to firms with high intangible capital and strong innovation clusters. Practical lessons for investors and quants (Priority: 3/5): Titman warns that simple factor strategies are widely known and should not be expected to work indefinitely at their historical strength. He stresses diversification, liquidity awareness, and realistic expectations for retail and institutional investors.

Key Arguments: Momentum is a natural test of market efficiency because underreaction should create return continuation and overreaction should create reversals. The 1993 study tested many formation and holding-period combinations and rejected the random-walk/null hypothesis for returns. The best practical momentum measure should exclude the most recent month because short-term reversal is strong. Momentum returns are partly behavioral, driven by investor overconfidence and underreaction, rather than purely risk-based. The decline in momentum after 2000 is consistent with more investors learning and trading on the signal, reducing its edge. Value and momentum should be combined because they are relatively uncorrelated and thus diversify well. Location matters materially for firm value creation; industry matters most, but geography still explains a meaningful share of outcomes. Innovation and intangible capital are especially powerful in disruptive eras, helping explain excess returns for firms in places like San Francisco and Seattle. Retail investors can tilt modestly toward factors like value and momentum without taking excessive risk if they remain diversified and disciplined. Quants often underestimate liquidity risk; major failures such as LTCM and 2007 are presented as examples of liquidity events being underestimated.

Data Points: Cited research output: 250+ papers/articles - Discussed as part of Sheridan Titman’s academic output and reputation Citations: 60,000+ citations - Referenced to illustrate influence in finance academia Momentum study formation/holding periods: Multiple intervals including 3, 6, 9, and 12 months - Titman described testing many combinations in the 1993 paper Best-known momentum specification: 6-month formation, 6-month holding - The main focus of the 1993 paper Short-term reversal window: 1 month - Titman noted strong reversals over a one-month horizon and said skipping the most recent week/month improves momentum performance Common practitioner measure: 12-1 momentum - Described as 12-month momentum excluding the most recent month Share of value from two cities: ~80% to 90% - Titman said most value created by new firms over 50 years came from two metro areas Location importance vs. industry: ~one-third as important - He estimated location explains about one-third as much as industry in value creation terms Momentum geography: U.S. and U.K. strong; Japan and China weaker/different - Cross-country pattern discussed in relation to market development and liquidity Timeline of weaker momentum: Post-2000; especially 2007-2009 - Titman linked weaker momentum to increased arbitrage and a bad crisis period Chinese market structure: A shares vs. B shares - He used identical-fundamentals share classes to isolate investor behavior Factor-combination paper: 2016 - Paper with Greg Fisher and Ronnie Shaw on combining value and momentum IPO concentration in cities: ~90% - He said about 90% of IPOs are concentrated in a small number of cities

Pivotal Quotes: "this was the obvious thing to look at" — Sheridan Titman: Explaining why momentum research should have been studied earlier as a basic test of market inefficiency "the best strategies were ones where we would have, say, a formation period of six months, and then we would skip a week" — Sheridan Titman: Describing how to reduce short-term reversal effects in momentum investing "It's behavioral. I don't put much weight on the rational stories." — Sheridan Titman: Stating his view on why momentum exists

Implications: Momentum remains useful, but its edge is likely smaller and more crowded than in the past. Investors should combine factors thoughtfully, respect liquidity, and avoid assuming academic anomalies will persist unchanged.