Which one do you want?

It has been raining issue index funds.

Just lately, an AMC launched a Nifty 500 Momentum 50 index fund, the primary on this index.

We have already got two momentum index merchandise within the markets. Nifty 200 Momentum 30 and Nifty Midcap 150 Momentum 50 index fund. And the momentum index funds have accomplished effectively not too long ago. Therefore, I’m not stunned to see the AMCs launching totally different variants of momentum merchandise.

Should you imagine in momentum investing, which variant of momentum will you decide? You could have atleast 3 selections of momentum indices now.

On this submit, let’s see how these momentum issue indices have carried out previously.

Sharing the efficiency abstract right here. Will focus on intimately later.

How does Momentum investing work?

In case you are a momentum investor, you imagine the shares which have risen within the current previous will carry on rising for some extra time. The intent is to experience onto such shares so long as they preserve rising or till yow will discover higher momentum shares. 

That is in stark distinction to how many people take into consideration choosing shares.

Standard funding strategy (or the worth strategy) is Purchase Low and Promote Excessive.

Momentum investing is: Purchase Excessive and Promote Greater.

A momentum index picks the very best momentum shares from a universe of shares.

As an illustration, Nifty 200 Momentum 30 index picks 30 shares with highest momentum rating from the universe of Nifty 200.

Nifty Midcap 150 Momentum 50 index picks 50 greatest momentum shares from Nifty Midcap 150.

Equally, Nifty 500 Momentum 50 picks prime 50 momentum shares from Nifty 500.

To assemble a momentum index fund, we want a definition of momentum. And this definition can differ. As an illustration, NiftyIndices, amongst different issues, considers value efficiency during the last 6 and 12 months. S&P, however, considers the efficiency of the final 12 months, excluding the newest month. I’ve written about S&P methodology in an earlier submit on momentum investing.

In Nifty momentum indices, the momentum Rating for every inventory (within the base index) relies on current 6-month and 12-month value return, adjusted for volatility. Adjustment for volatility is vital. This ensures that extra unstable shares get decrease scores. Thus, even in a momentum portfolio, the choice is in direction of shares which have had a smoother rise. 

Take into account shares A and B with the next value trajectory.

Inventory A: 100, 110, 120, 125, 130, 145, 165, 180, 200

Inventory B: 100, 150, 120, 175, 140, 195, 160, 230, 200

Whereas each the shares have doubled, Inventory A can have a better momentum rating because it was much less unstable in comparison with inventory B. Therefore, momentum investing is not only investing in frothy shares.

I’ll skip the remaining particulars. These particulars are vital too however you may learn the detailed methodology in this doc.

Inventory weight is capped at decrease of 5% or 5 instances the burden within the underlying base index.

Issues to bear in mind whereas evaluating Issue Index Merchandise

1. When an element index fund is launched, it’s truthful to imagine that the underlying issue index would have accomplished fairly effectively within the backtest knowledge. If the issue index has not accomplished effectively previously, it wouldn’t discover many takers on the availability facet (AMCs) or on the demand facet (buyers).
2. Therefore, take such index fund launches and my evaluation on this submit with a pinch of salt. The previous outcomes can be good, in any other case the AMC wouldn’t launch the index fund and I wouldn’t be scripting this submit at present.
3. Previous efficiency (or outperformance) is not any assure of future efficiency (outperformance).
4. I’m not very comfy with the very excessive alpha (extra return) over the bottom benchmark index. As an illustration, after I see Nifty Midcap 150 Momentum 50 index has delivered an alpha (extra return) of seven% over Nifty Midcap 150 index over the previous 15 years (ofcourse in backtests), I get a bit sceptical.
5. If an funding technique has accomplished effectively in backtests and continues to go effectively going ahead, you may count on buyers to pile in some huge cash into that technique. Because the funds stream in, the alpha ought to shrink and will even vanish. Therefore, if you’d like want to spend money on an element index product based mostly on previous performace and conviction, be happy to try this however you should rationalize your expectatations about extra returns. Anticipating an alpha of 7-10% p.a. over the benchmark going ahead is asking for an excessive amount of.
6. There isn’t any assure that such alpha will maintain sooner or later. It’s attainable that the issue technique could underperform going ahead. Once more, no certainty about something. Nevertheless, you should permit this possbility whereas deciding the guess measurement.
7. I wrote a submit not too long ago the place I in contrast the efficiency of assorted issue indices because the launch in opposition to their respective benchmark universe. An element index fund which did expectionally effectively within the backtests underperformed massively after the launch of the index.
8. No funding technique, regardless of how good, will do effectively on a regular basis. It can undergo durations of underperformance. It’s completely regular. Actually, such durations of underperformance will be the supply of alpha of any funding technique over the long run. As an illustration, if fairness markets did higher than financial institution fastened deposits on a regular basis, then everybody would spend money on shares and nobody would spend money on financial institution fastened deposits. Step by step, the shares costs can be bid excessive sufficient that alpha vanishes.
9. If you spend money on any energetic fund or an element index fund, you must have the conviction within the fund supervisor or the funding technique. Or else you’ll enter/exit at unsuitable instances. Keep in mind, funding returns will be totally different from investor returns.
10. You don’t spend money on the index. You spend money on an index fund or an ETF that should purchase and promote shares. As you progress broaden the universe of shares, you even have to understand that smaller shares could not have very excessive liquidity. Whereas the index suppliers attempt to maintain such points (by stopping very heavy allocation to smaller shares), we will’t fully ignore this issue. Mentioned this side in my submit on equal weight indices.

I’ll current the efficiency of assorted momentum indices and depart all the things to your judgement.

I evaluate the month-to-month knowledge (and never every day knowledge) of Value index. From April 1, 2005 to August 31, 2024.

Nifty Momentum Indices: Efficiency Abstract

Nifty Momentum Indices: Calender 12 months Returns

Momentum Indices: Rolling Returns

Momentum indices have accomplished fairly effectively on the rolling returns entrance too. This isn’t stunning given the extensive outperformance within the CAGR over the long run.

Momentum Indices: Volatility and Most Drawdown

Alongside anticipated strains. You’ll count on momentum indices to be extra unstable and present increased drawdowns than Nifty 50.

Momentum Indices: Efficiency throughout numerous market phases

I in contrast the efficiency of assorted momentum indices over totally different market phases. Throughout numerous phases of Nifty returns.

Right here too, the efficiency of momentum indices (keep in mind most of this knowledge is back-fitted) is kind of spectacular.  Aside from minor underperformance when Nifty has returned lower than 10%, the momentum indices have accomplished higher throughout all different market phases.

Which Momentum index must you spend money on?

Earlier than you get there, you should first determine whether or not you should spend money on any momentum index. Previous efficiency seems nice however there is no such thing as a assure that this efficiency will maintain. Any technique goes by means of durations of underperformance or outperformance. You will need to have conviction to stay with the technique throughout poor phases.

Do you imagine in momentum investing?

Should you don’t, then you should not spend money on momentum index funds.

Should you do, then you should determine how a lot to allocate to momentum technique. Don’t get swayed by the previous efficiency proven on this submit and put all of your eggs in a single basket. Assemble your portfolio properly.

After you have determined the allocation, you should decide a momentum index fund or ETF. You could have 3 momentum indices and a number of funds monitoring these indices. Which index to decide on? I depart that call to your funding acumen and judgement.

Personally, earlier than choosing an index to take a position (from a set of comparable funds/methods), I would like to see how these indices carried out throughout opposed market phases. Would favor the one which retains me rather less frightened throughout unhealthy market phases. Helps me in sustaining funding self-discipline and that’s additionally the important thing to funding success.

Picture Credit score: Unsplash

Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM on no account assure efficiency of the middleman or present any assurance of returns to buyers. Funding in securities market is topic to market dangers. Learn all of the associated paperwork rigorously earlier than investing.

This submit is for training function alone and is NOT funding recommendation. This isn’t a advice to take a position or NOT spend money on any product. The securities, devices, or indices quoted are for illustration solely and are usually not recommendatory. My views could also be biased, and I’ll select to not deal with facets that you just think about vital. Your monetary objectives could also be totally different. You could have a special danger profile. It’s possible you’ll be in a special life stage than I’m in. Therefore, you should NOT base your funding choices based mostly on my writings. There isn’t any one-size-fits-all resolution in investments. What could also be a superb funding for sure buyers could NOT be good for others. And vice versa. Due to this fact, learn and perceive the product phrases and situations and think about your danger profile, necessities, and suitability earlier than investing in any funding product or following an funding strategy.