Is Momentum A Good Bet At Market Peaks?

Momentum investing has significantly outperformed many other strategies, especially in recent years. The Nifty200 Momentum 30 index, for instance, has posted an impressive 25.7% return over the past five years, outpacing the Nifty 200 index's 17.4% return. However, with the stock market at historic highs, is momentum still a reliable strategy?

Understanding Momentum's Performance and Risks

Momentum investing, or the 'buy high, sell higher' approach, has proven its worth during the past few years of almost uninterrupted market growth. This success has led many investors to expect continuous gains from momentum strategies. However, experts advise a recalibration of expectations. Investing strategies, including momentum, tend to oscillate between periods of strong performance and underperformance. After a period of significant outperformance, some mean reversion is natural and should be anticipated.

Momentum investing can be quite risky. When market conditions shift, the same strategy that led to impressive gains can result in substantial losses. New investors in momentum strategies might find it challenging to navigate these shifts. Historical data reveals that since 2006, the Nifty200 Momentum 30 index has been near market highs 36% of the time. When the index is away from these peaks, the probability of a negative one-year forward return is 17%. This probability rises to 27.5% near market peaks. Conversely, near market lows, the probability of a negative one-year forward return drops significantly to 1.5%.

Strategic Adjustments and Diversification

Despite the risks, momentum can still offer good returns even at market peaks. Historical data shows that the average one-year forward return from the momentum index near market peaks is 18.3%, only slightly lower than the 22.6% at other times. This indicates that while there is a higher risk of negative returns at market peaks, the potential for gains remains significant.

Momentum strategies can be implemented in various ways, each with its strengths. For example, the Nifty200 Momentum 30 index selects stocks based on six-month and 12-month price performance and rebalances every six months. Other strategies might use shorter or longer price trends and rebalance more frequently, such as monthly or quarterly. The frequency of rebalancing is crucial because it can help mitigate the risk of 'signal decay,' where the portfolio fails to exit stocks before their price strength wanes.

Diversification within the momentum portfolio is also essential. By spreading investments across different segments, investors can reduce the impact of price declines in specific areas. Additionally, maintaining an allocation to momentum that aligns with one's risk tolerance can help manage potential losses.

Momentum Mutual Funds

Momentum mutual funds are designed to capitalize on the momentum investing strategy. These funds typically invest in stocks that have demonstrated strong performance over a specific period, such as the past six to twelve months. Here are a few notable momentum mutual funds:

1. Edelweiss MSCI India Momentum Index Fund: This fund tracks the MSCI India Momentum Index, which includes stocks showing positive momentum. It aims to provide returns that closely correspond to the performance of the underlying index, subject to tracking error.

2. ICICI Prudential Nifty 200 Momentum 30 Index Fund: This fund invests in the Nifty 200 Momentum 30 Index, which consists of the top 30 companies within the Nifty 200 based on their momentum scores. The fund rebalances its portfolio semi-annually.

3. Tata Nifty 200 Momentum 30 Index Fund: Similar to the ICICI fund, this one also tracks the Nifty 200 Momentum 30 Index. It seeks to replicate the performance of the index by investing in its constituent stocks and rebalancing semi-annually.

4. Invesco India - Invesco EQQQ NASDAQ-100 ETF: While not strictly a momentum fund, it often captures momentum stocks due to its focus on the top 100 non-financial companies listed on NASDAQ. Its inherent growth focus aligns well with momentum investing principles.

5. Motilal Oswal Nifty 200 Momentum 30 ETF: This ETF tracks the Nifty 200 Momentum 30 Index, providing exposure to the top 30 companies based on their momentum scores. The fund rebalances semi-annually to maintain its momentum strategy.

6. DSP Quant Fund: This fund uses a quantitative approach to select stocks with strong momentum and other financial metrics. It aims to deliver superior risk-adjusted returns by systematically investing in high-momentum stocks.

7. SBI ETF Nifty 50: Although not purely a momentum fund, this ETF often includes high-momentum stocks due to its focus on the top 50 companies listed on the NSE. It provides diversified exposure to leading Indian companies.

8. HDFC Sensex ETF: Another fund that, while not purely momentum-based, includes stocks that show strong momentum due to its focus on the top 30 companies in the BSE Sensex. It provides a good mix of high-performing stocks.

9. Nippon India ETF Nifty 50 Value 20: This ETF includes high-momentum stocks among its top 20 value stocks from the Nifty 50, balancing momentum with value investing principles.

10. Axis Banking ETF: Focused on the banking sector, this ETF includes high-momentum stocks from the top banks listed in India. It provides sector-specific exposure with a momentum tilt.

11. Mirae Asset Focused Fund: While this fund is not exclusively a momentum fund, it includes a significant number of high-momentum stocks within its focused portfolio of 20-30 stocks, aiming for high growth potential.

Combining Momentum with Other Factors

One effective way to enhance the risk-return profile of a momentum strategy is to combine it with other factors, such as low volatility or quality. Historical evidence suggests that such combinations have yielded better risk-adjusted returns. For instance, ETFs based on indices like the Nifty Alpha Low Volatility 30 can offer a more balanced approach, especially as the market ventures into less predictable territory. Upcoming funds that integrate momentum with factors like growth, quality, and value can dynamically adjust to shifting market trends, further optimizing performance.

Conclusion

Momentum investing has delivered impressive returns, even at market peaks. However, it is crucial to approach this strategy with caution and to be prepared for potential periods of underperformance. Diversifying within the momentum portfolio, adjusting the frequency of rebalancing, and combining momentum with other factors can help manage risks and enhance returns. By adopting these strategies, investors can continue to benefit from momentum investing in various market conditions.