Which one do you want?

It has been raining issue index funds.

Not too long ago, 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 achieved effectively just lately. Therefore, I’m not shocked to see the AMCs launching completely different variants of momentum merchandise.

When you consider in momentum investing, which variant of momentum will you choose? You might 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 talk about intimately later.

How does Momentum investing work?

If you’re a momentum investor, you consider 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 maintain rising or till you will discover higher momentum shares. 

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

Typical funding method (or the worth method) is Purchase Low and Promote Excessive.

Momentum investing is: Purchase Excessive and Promote Larger.

A momentum index picks the perfect momentum shares from a universe of shares.

For example, 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 finest 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. For example, NiftyIndices, amongst different issues, considers value efficiency during the last 6 and 12 months. S&P, alternatively, 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) is predicated on current 6-month and 12-month value return, adjusted for volatility. Adjustment for volatility is essential. This ensures that extra unstable shares get decrease scores. Thus, even in a momentum portfolio, the choice is in the direction of shares which have had a smoother rise. 

Contemplate 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 may have a better momentum rating because it was much less unstable in comparison with inventory B. Therefore, momentum investing isn’t just investing in frothy shares.

I’ll skip the remaining particulars. These particulars are essential too however you possibly can learn the detailed methodology in this document.

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

Issues to remember 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 achieved fairly effectively within the backtest information. If the issue index has not achieved effectively previously, it wouldn’t discover many takers on the provision 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 penning this submit at this time.
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. For example, once 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 achieved effectively in backtests and continues to go effectively going ahead, you possibly can count on buyers to pile in some huge cash into that technique. Because the funds move in, the alpha ought to shrink and will even vanish. Therefore, if you would like want to put money into an element index product primarily based on previous performace and conviction, be at liberty to do 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 is no such thing as a assure that such alpha will maintain sooner or later. It’s doable that the issue technique might underperform going ahead. Once more, no certainty about something. Nonetheless, you should enable this possbility whereas deciding the bet size.
7. I wrote a submit just lately the place I compared the performance of various factor indices since the launch against 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, irrespective of how good, will do effectively on a regular basis. It’ll undergo durations of underperformance. It’s completely regular. Actually, such durations of underperformance often is the supply of alpha of any funding technique over the long run. For example, if fairness markets did higher than financial institution mounted deposits on a regular basis, then everybody would put money into shares and nobody would put money into financial institution mounted deposits. Steadily, the shares costs can be bid excessive sufficient that alpha vanishes.
9. While you put money into any energetic fund or an element index fund, it is best to have the conviction within the fund supervisor or the funding technique. Or else you’ll enter/exit at incorrect instances. Bear in mind, funding returns may be completely different from investor returns.
10. You don’t put money into the index. You put money into 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 might not have very excessive liquidity. Whereas the index suppliers attempt to care for such points (by stopping very heavy allocation to smaller shares), we are able to’t utterly ignore this issue. Mentioned this side in my submit on equal weight indices.

I’ll current the efficiency of assorted momentum indices and go away every part to your judgement.

I examine the month-to-month information (and never each day information) of Value index. From April 1, 2005 to August 31, 2024.

Nifty Momentum Indices: Efficiency Abstract

Nifty Momentum Indices: Calender Yr Returns

Momentum Indices: Rolling Returns

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

Momentum Indices: Volatility and Most Drawdown

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

Momentum Indices: Efficiency throughout varied market phases

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

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

Which Momentum index do you have to put money into?

Earlier than you get there, you should first resolve whether or not you should put money into any momentum index. Previous efficiency appears nice however there is no such thing as a assure that this efficiency will maintain. Any technique goes by durations of underperformance or outperformance. It’s essential to have conviction to stay with the technique throughout poor phases.

Do you consider in momentum investing?

When you don’t, then you should not put money into momentum index funds.

When you do, then you should resolve 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. Construct your portfolio wisely.

Upon getting determined the allocation, you should choose a momentum index fund or ETF. You might have 3 momentum indices and a number of funds monitoring these indices. Which index to decide on? I go away that call to your funding acumen and judgement.

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

Picture Credit score: Unsplash

Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM by no means 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 objective alone and is NOT funding recommendation. This isn’t a advice to speculate or NOT put money into any product. The securities, devices, or indices quoted are for illustration solely and will not be recommendatory. My views could also be biased, and I’ll select to not give attention to points that you simply take into account essential. Your monetary targets could also be completely different. You could have a distinct danger profile. You could be in a distinct life stage than I’m in. Therefore, you should NOT base your funding selections primarily based on my writings. There is no such thing as a one-size-fits-all answer in investments. What could also be an excellent funding for sure buyers might NOT be good for others. And vice versa. Due to this fact, learn and perceive the product phrases and situations and take into account your danger profile, necessities, and suitability earlier than investing in any funding product or following an funding method.