Momentum Investing: All You Need to Know About Momentum Mutual Funds

July 3, 2024 Mutual Fund

The mutual fund industry in India has witnessed significant growth in 2023. The AUM of the Indian MF Industry has grown from Rs 10.11 trillion as of May 31, 2014, to Rs 58.91 trillion as of May 31, 2024, around 6 fold increase in a decade and more than a 2-fold increase in a span of 5 years.

This growth has been driven by several factors, including a rise in disposable incomes, increased awareness of mutual funds, strong performance in the equity market, etc. Amidst the various changes that the equity market has been going through over the years with the launch of new themes and categories, Momentum Investing particularly has caught the eye of many investors.

Certainly, Momentum Mutual Funds are gaining traction in India; they are a relatively new category of mutual funds. These funds have been outperforming traditional index funds in recent years, and investors are taking note of it.

Are you looking for some of the best momentum mutual funds to add in your portfolio? Well, you have landed at the right page.

[Read: How Many Mutual Funds Should I Invest In? Avoid Over-Diversifying Your Portfolio]

Understanding Momentum Investing

Momentum Mutual Funds focus on an investment strategy called ‘Momentum Investing’. The goal of momentum investing is to capitalise on the tendency of stocks that have been performing well to continue performing well in the future.

The fundamental principle behind momentum investing is that stocks or other financial assets that have performed well in the past will continue to perform well in the future, while those that have performed poorly will continue to perform poorly.

Momentum investing relies on the hypothesis that financial instruments which have shown an upward or downward price trend will continue to do so for a certain period. This strategy is grounded in behavioral finance, which suggests that investors’ psychological biases and market sentiment can drive prices in the short term.

Momentum mutual funds are designed to systematically capture the momentum effect by employing various strategies to identify and invest in securities that exhibit strong positive momentum.

Momentum Investing is strictly a technical trading strategy. The operational performance of a company is also a factor in momentum investing. Technical indicators are used in momentum investing to analyse a security and detect patterns, as well as to measure the intensity of the trend and the degree of price momentum in the market.

Thus, momentum investing tries to ride this wave or momentum of stocks that are doing well and then jump on to the next wave before the first one slows down.

Momentum Mutual Funds strategically invest in stocks that exhibit strong upward price momentum; the strategy is based on the idea that stocks that have been outperforming the market in the past are more likely to continue such outperformance in the future.

As there is no assurance that the stocks that have been outperforming in the past will maintain their upward trend, Momentum Mutual Funds can be a risky investment. However, they can also be very rewarding, as they have the potential to yield high returns.

Momentum Mutual Funds are actively managed, meaning the fund manager selects the stocks that they believe will continue to outperform, considering the investor interest and momentum in it. This can be a risky strategy, as there is no guarantee that the stocks that have been beating in the past will continue to do so. However, momentum mutual funds can also be advantageous, as they have the potential to generate high returns.

Overall, Momentum Mutual Funds offer investors a new and exciting way to invest in the stock market. However, it is important to remember that momentum investing is not without risk, and investors should carefully consider their risk tolerance before investing in this strategy.

[Read: These Thematic Mutual Funds Offered Over 50% Returns In 1 Year. Should You Invest in Them?]

How Momentum Investing in Mutual Funds Works?

Although momentum investing is a stock trading approach, it is now popular amongst mutual fund investors as a lucrative investment style. Mutual funds focusing on a momentum investing strategy can be managed actively or passively.

Active Momentum Mutual Funds are managed by a fund manager who selects stocks based on their momentum. The fund manager will typically use technical analysis to identify stocks that are exhibiting strong upward price momentum. Active momentum mutual funds can be more expensive than passive momentum funds, as they require active management.

There are various factors, as mentioned below, to identify the momentum stocks:

• Price Momentum is the most common factor used to identify momentum stocks. It simply measures how much the price of a stock has changed over a recent period of time.
• Volume Momentum measures the amount of trading volume in a stock. Stocks with high volume momentum are more likely to be volatile but may offer greater potential for returns.
• Relative Strength Index (RSI): The RSI is a technical indicator that measures the speed and magnitude of price movements in a stock. Stocks with an RSI above 70 are considered to be overbought, while stocks with an RSI below 30 are considered to be oversold.

Passive Momentum Mutual Funds track a momentum index, such as the Nifty200 Momentum 30 Index. This means that the fund will invest in the stocks that are currently in the index, regardless of their current momentum. Passive momentum funds are a low-cost option than active momentum funds, as they do not require active management.

There are 12 schemes focusing on momentum indices in the Indian mutual fund industry. All index funds tracking the Nifty200 Momentum 30 Index and the Nifty Midcap 150 Momentum 50 Index have been one of the top performers based on YTD performance.

Data as of July 02, 2024
Past performance is not an indicator of future returns.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF, data collated by PersonalFN Research) 

The Nifty200 Momentum 30 Index tracks the performance of the top 30 companies within the Nifty 200 that have the highest momentum score. Meanwhile, the Nifty Midcap150 Momentum 50 Index aims to track the performance of the top 50 companies within the Nifty Midcap 150 selected based on their Normalised Momentum Score.

These indices are reviewed semi-annually (June and December). To qualify for the momentum index, stocks should be listed for more than one year and be available for trading in the derivatives segment.

Momentum Mutual Funds mainly follow growth or GARP (Growth at a Reasonable Price) investment style. Growth investing focuses on companies with high growth potential, even if they are currently trading at a premium. This is because momentum investors believe that these companies will continue to outperform the market in the future.

GARP investing, which stands for ‘Growth At a Reasonable Price,’ is a hybrid investment strategy combining elements of growth and value investing. The GARP approach looks for companies with strong growth prospects but currently trading at a price that is considered fair or even undervalued.

Having said that, Momentum Mutual Funds are a type of investment fund that attempts to capitalise on the momentum effect, which is the tendency of stocks that have recently been rising in price to continue to rise.

The benefits of Investing in Momentum Mutual Funds Are as follows:

• The Potential for Higher Returns: Momentum Mutual Funds have historically outperformed the stock market over the long term.
• Diversification Benefits: Momentum Mutual Funds can provide diversification benefits to your investment portfolio.
• Professional Management: Momentum Mutual Funds are typically managed by professional investment managers who have experience in selecting stocks that are exhibiting strong momentum.

There are also some risks associated with investing in Momentum Mutual Funds. These include:

• Increased Volatility: Momentum stocks can be more volatile than the overall stock market. This means that the value of your investment could fluctuate significantly.
• The Possibility of Losses: Momentum Mutual Funds are not immune to losses. They may be more likely to lose money during market downturns.
• The Risk of Chasing Momentum: Momentum investors may be tempted to chase stocks that have already experienced significant price gains. This can be risky, as these stocks may be due for a correction.

When it comes to investing, you could do a Google Search ‘Best Momentum Mutual Funds’, but that’s not the right approach. It is necessary to look into various qualitative and quantitative factors before investing in mutual funds. Analysing the scheme’s past performance is one of the prevalent factors.

Now, let’s throw some light on how the Momentum Mutual Funds have performed in a while…

Table: Performance of Top 5 Momentum Mutual Funds (based on YTD returns)

Data as of July 02, 2024
Past performance is not an indicator of future returns.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF, data collated by PersonalFN Research) 

As you can see from the above table, the momentum schemes have performed well, which is mainly due to the positive equity markets and the strong performance of stocks from various leading sectors focused of growth & expansion.

Momentum mutual funds are designed to capitalize on the trend-following strategy, investing in stocks that have demonstrated strong performance over a specified period. Kotak Nifty 200 Momentum 30 Index Fund and Edelweiss Nifty Midcap150 Momentum 50 Index Fund have outperformed its peers in both the medium and long term, making it a top choice for momentum investing.

While Tata Nifty Midcap 150 Momentum 50 Index Fund, Bandhan Nifty200 Momentum 30 Index Fund and ICICI Pru Nifty 200 Momentum 30 Index Fund have demonstrated consistent returns over all periods.

Taking an average across all funds, we see that the returns have been consistently strong over the past 3 months, 6 months, and 1 year. This highlights the potential of momentum investing to generate significant gains in a bull market. However, it is not yet clear how these funds will perform in different market cycles, especially in bearish markets.

Although Passive Momentum Mutual Funds have delivered significant returns in the short run, it is too soon to predict whether this fund category will continue to outperform the broader indices.

It’s important to remember that past performance is not necessarily indicative of future results. Momentum investing can be susceptible to market volatility, and these funds may experience losses if the market trends reverse.

[Read: Large Cap Funds Have Begun to Outperform Their Benchmark. Here’s Why]

Should one consider investing in Momentum Mutual Funds?

There are several reasons why Momentum Funds are becoming more popular in India. The Indian stock market has been on an upward trend for the past few years, which has created a favourable environment for momentum investing.

Many investors are looking for ways to generate higher returns than traditional index funds. There is a growing number of momentum funds available in the market, making it easier for investors to invest in this strategy.

Though momentum investing can be rewarding, it might not outperform all factors throughout the year. Do note that the outcome of a momentum strategy-based portfolio may witness significant ups and downs. Therefore, to provide an optimal balance in the overall portfolio, one should consider combining other factors, such as low volatility to generate relatively stable returns.

[Read: 5 Best Mutual Fund Types to Benefit During Modi’s Third Term]

Many momentum strategies have generated returns higher than broader indices, and the outperformance has been noteworthy at times. Remember, although the idea of riding the momentum towards higher profits is indeed promising, these funds are still new and do not have a long performance track record. There is not enough data to justify the success of this momentum strategy.

If you have some appetite for volatility and identify as a sufficiently aggressive investor, then you can combine momentum funds with other categories like active or passive large-cap funds, flexi-caps, mid-caps, etc. This will definitely give you some edge and strategy diversification, but one must limit their overall portfolio exposure in momentum funds to 5-10%.

To conclude…

Momentum investing can be a valuable tool for investors seeking to capitalize on short-term market trends. However, it’s essential to understand its limitations and potential risks. So, even though momentum mutual funds are a good option for the satellite part of your equity portfolio, they should perform in a direction that contributes towards portfolio growth. If not, it merely makes the portfolio more cluttered.

Investors should not solely rely on momentum mutual funds and instead consider diversifying their portfolios with a combination of investment strategies based on their individual risk tolerance and investment goals.

If you are unsure whether or not momentum mutual funds are a wise choice, consult a SEBI-registered financial advisor. They may assist you in determining whether momentum mutual funds are a suitable fit for your portfolio by helping you evaluate your personal risk tolerance and investing objectives.

Disclaimer: PersonalFN does not receive any monetary compensation from the fund house or scheme names stated in the article.

This article first appeared on PersonalFN here