Alpha Architect: Best-In-Class Momentum, Now 20% Cheaper (BATS:QMOM)

In an earlier article, I wrote in quite some detail about the Alpha Architect U.S. Quantitative Momentum ETF (QMOM), its investment process, and how it compares to other momentum exchange-traded funds (“ETFs”). In my opinion, QMOM is currently one of the best and most active momentum-implementations out there.

The idea for this follow-up comes from a recent Tweet by Wes Gray, the CEO of Alpha Architect, which is of course the asset manager behind QMOM. The Tweet refers to an official press release which reads:

Alpha Architect is pleased to announce that it has reduced fees up to 20% on its focused factor ETFs, which seek high active-share exposure to the value, momentum, and trend factors.

Effective 1/31/2023, Alpha Architect is lowering management fees on the following ETFs:

[…]

• Alpha Architect U.S. Quantitative Momentum ETF (Ticker: QMOM) management fee will be lowered from 0.49% to 0.39%.

[…]

Source: Alpha Architect Press Release from December 1, 2022.

Needless to say, this is nice for current and prospective investors of QMOM, as they will get 10 basis points extra without doing anything. It also reminded me that I did not mention management fees at all in my previous article. So I will make up for that here.

Management Fees of Momentum ETFs

The following chart shows the total expense ratios of QMOM and the three other momentum ETFs from my original (arguably subjective) peer group. In a comment to one of my other articles, a reader also suggested looking at the Invesco S&P 500 Momentum ETF (SPMO). So, I added this one to the analysis.

Even after the reduction from 0.49% to 0.39%, QMOM has still the second-highest total expense ratio from this peer group. Only the AQR Large Cap Momentum Style fund with 0.41% is more expensive. All other ETFs post fees between 0.12% and 0.15%, so substantially cheaper.

Now, Alpha Architect is well aware of this issue and provides an explanation in their value proposition of “Affordable Alpha”:

According to this slide, Alpha Architect attempts to be somewhere between passive index funds and conventional active funds in terms of fees. With now 0.39% for the QMOM ETF, I think this is fulfilled.

The more important question, of course, is whether those fees are indeed justified. In the end, 0.39% are still three times as high as the fees of MTUM, JMOM, or SPMO. I would argue, however, that 0.39% is still quite low on an absolute basis. Logically, Alpha Architect justifies the higher fee with higher expected alpha. And indeed, as I mentioned in my first article on the investment process, QMOM historically delivered a more active, more concentrated, and ultimately better-performing momentum exposure than the “Smart Beta” ETFs.

We are not competing with Passive Indexers, or Closet Indexers / Smart Beta. […] Our competitive angle is squarely targeted at expensive active strategies, and our mission is to make these high-expected-performance strategies more affordable.

Source: Alpha Architect Website

This is not a coincidence. As the quote above shows, it is the outspoken goal of Alpha Architect to offer sophisticated active strategies like the momentum factor for competitive fees. In my opinion, they also achieve this. The QMOM ETF is a truly active momentum strategy and only holds 50 stocks in an equal-weighted portfolio. The active share according to the latest factsheet as of September 2022 is 95.62%, which is very high (a completely passive fund has an active share of 0%).

Okay, so the point of truly active portfolio construction is also fulfilled. That leaves the important question of expected alpha, i.e., outperformance for investors. While past performance never guarantees anything, it is the only thing we can reliably measure. In my opinion, it is difficult to come up with a reasonable estimates of “expected alphas” for different momentum-strategies. So, the following table summarizes realized returns since 2017.

Over the last 5 years (as of November 30, 2022), QMOM delivered on its promise. The ETF outperformed both the SPDR S&P 500 Trust ETF (SPY) and the academic momentum benchmark of Kenneth French by 1.01 and 2.18 percentage points, respectively. Except when compared to the SPMO ETF, this is the best-performing momentum strategy despite three-times higher fees (all performance statistics are after fees). So, at least historically, it delivered better results than most of the cheaper alternatives. I think this is similar to all things in life. If you identify a differentiated service or product, you will typically not get it for a discount price, but it is often worth to pay the premium.

Given that it is the first time that I include the SPMO ETF, a few comments about why the ETF performed so well. SPMO is solely focused on the S&P 500 universe and holds a market-cap weighted portfolio of the 100 stocks with highest price-momentum. This probably lead to strong exposure to the long-outperforming large cap growth names over the last. I guess this is the main reason for the strong 5-year returns. However, as this ETF also just rebalances twice a year, it suffered in 2022 when things reversed quite brutally. As a consequence, the “faster” quarterly rebalancing QMOM considerably outperformed SPMO year to date (-7.55% for SPMO vs. 1.04% for QMOM as of November 30, 2022).

Conclusion

The most important point of this article is that the fee reduction makes QMOM even more attractive for investors. You get 10 more basis points without doing anything. All else equal, this increases investors’ chance of outperformance, which is obviously great. If you liked the ETF for 0.49% per year, you should like it even more for 0.39%.

Apart from that, I think it also says a lot about an asset manager to go such a step. Of course, they also use the voluntary fee reduction to market themselves as investor/client-friendly while keeping their offerings competitive. I don’t want to be overly skeptical, but fees in the asset management business came down heavily. So, I think as a manager, you have no choice but to improve operational efficiency to remain competitive.

On the other hand, however, they are giving up 20% of immediate revenues for their firm even though they don’t necessarily have to. No fund manager who just wants to enrich him/herself would do that. In fact, this is already the second fee-cut within 4 years after they lowered their fees for Alpha Architect U.S. Quantitative Momentum ETF by 38% back in 2019. Together, this amounts to a fee reduction of 50% in just 4 years. I think this is very investor-friendly, and makes me confident that a manager of integrity stands behind the well-designed and successful investment process of Alpha Architect U.S. Quantitative Momentum ETF.