Understanding Momentum Strategy
For investors, the allure of “buying high and selling higher” can be too tempting to resist. A select group of investors, particularly those who have a greater risk appetite and long-term investment horizon, may assign 10-15% of their portfolio to this high-risk, high-reward investment strategy known as Momentum Strategy.
Currently, about a dozen mutual fund schemes in India offer a chance to play around with this strategy. One of the top performers among large-cap equity funds, the Nifty200 Momentum 30 Index Fund has demonstrated its potential based on one-year performance. New additions to the momentum-focused funds include the Edelweiss Nifty Midcap 150 Momentum 50 Index Fund and Samco Mutual Fund’s Samco Active Momentum Fund.
Momentum Strategy Explained
Sharwan Goyal, Fund Manager and Head of Passive, Arbitrage, and Quant Strategies at UTI AMC, defines momentum investing as a strategy to exploit ongoing market trends. It involves the purchase of securities that have shown robust price momentum, with the expectation that the trend will persist.
Analysis of data from the past 15 years supports this notion. Over a five-year rolling period, returns from momentum indices tend to surpass those provided by the Nifty 200 and Nifty Midcap 150 indices.
The Risks of Momentum Investing
Despite its potential, momentum investing isn’t without its risks. In fact, it’s often considered a risky strategy due to its inherent volatility. Momentum indices have shown resilience during market falls and slightly better performance in bullish markets.
However, Goyal emphasizes that momentum strategies might not consistently outperform all factors throughout the year. There could be considerable fluctuations in a momentum-based portfolio. Thus, it’s advisable to balance it out by combining it with other factors such as low volatility.
Understanding Momentum Indices
Momentum indices can be volatile. Over the last 10 years, the maximum drawdown observed by these indices was a significant 39 percent. As Sailesh Jain, Fund Manager, Tata Mutual Fund points out, investors should be aware of the risks associated with momentum strategies. These include increased turnover, transaction costs, and the potential for momentum crashes during periods of market stress. Thus, he advises investors to dedicate only up to 10-15 percent of their portfolio to a momentum strategy.
High momentum stocks are typically included in these indices. These stocks tend to display a higher standard deviation compared to their respective parent indices and the Nifty 50 TRI. Standard deviation measures the dispersion of a dataset relative to its mean, which can be used to gauge the relative riskiness of an asset.
Momentum Strategy Fund Composition
The top five stocks in the Nifty 200 Momentum 30 index funds as of June 30, 2023, were Cholamandalam Investment and Finance Co, Bajaj Auto, Godrej Consumer Products, Axis Bank, and TVS Motor Company. The dominant sectors were Finance, Banks, and Automobiles.
In the Nifty Midcap150 Momentum 50 index funds, the leading stocks were TVS Motor Company, The Indian Hotels Company, CG Power and Industrial Solutions, Max Healthcare Institute, and Cummins India. The primary sectors represented were Industrial Products, Finance, and Auto Components.
As of June 2023, the assets under management in momentum-based funds amounted to Rs 3,095 crore. As this strategy continues to gain traction among investors, understanding its workings, potential benefits, and inherent risks become essential for anyone seeking to navigate the unpredictable currents of market trends.