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 executed effectively not too long ago. Therefore, I’m not stunned to see the AMCs launching completely different variants of momentum merchandise.

For those who consider in momentum investing, which variant of momentum will you choose? You’ve gotten atleast 3 decisions of momentum indices now.

On this put up, 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?

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 journey onto such shares so long as they hold 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 strategy (or the worth strategy) is Purchase Low and Promote Excessive.

Momentum investing is: Purchase Excessive and Promote Increased.

A momentum index picks the very best 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 high 50 momentum shares from Nifty 500.

To assemble a momentum index fund, we’d like a definition of momentum. And this definition can differ. For example, NiftyIndices, amongst different issues, considers worth efficiency over the past 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 put up 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 worth 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 worth 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 the next 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 essential too however you’ll be able to 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 honest to imagine that the underlying issue index would have executed fairly effectively within the backtest information. If the issue index has not executed effectively previously, it wouldn’t discover many takers on the availability aspect (AMCs) or on the demand aspect (buyers).
2. Therefore, take such index fund launches and my evaluation on this put up 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 put up right now.
3. Previous efficiency (or outperformance) is not any assure of future efficiency (outperformance).
4. I’m not very snug 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 executed effectively in backtests and continues to go effectively going ahead, you’ll be able to count on buyers to pile in some huge cash into that technique. Because the funds circulation in, the alpha ought to shrink and should even vanish. Therefore, if you would like want to spend money on an element index product based mostly on previous performace and conviction, be happy to do this however it’s essential to 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 a assure that such alpha will maintain sooner or later. It’s attainable that the issue technique might underperform going ahead. Once more, no certainty about something. Nonetheless, it’s essential to permit this possbility whereas deciding the guess measurement.
7. I wrote a put up 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’s going to undergo intervals of underperformance. It’s completely regular. The truth is, such intervals 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 fastened deposits on a regular basis, then everybody would spend money on shares and nobody would spend money on financial institution fastened deposits. Progressively, the shares costs can be bid excessive sufficient that alpha vanishes.
9. While you spend money on any lively 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 incorrect instances. Bear in mind, funding returns might be completely 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 might not have very excessive liquidity. Whereas the index suppliers attempt to handle such points (by stopping very heavy allocation to smaller shares), we are able to’t fully ignore this issue. Mentioned this side in my put up on equal weight indices.

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

I evaluate the month-to-month information (and never day by day information) 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 executed fairly effectively on the rolling returns entrance too. This isn’t shocking given the broad 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 larger drawdowns than Nifty 50.

Momentum Indices: Efficiency throughout numerous market phases

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

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

Which Momentum index do you have to spend money on?

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

Do you consider in momentum investing?

For those who don’t, then it’s essential to not spend money on momentum index funds.

For those who do, then it’s essential to resolve how a lot to allocate to momentum technique. Don’t get swayed by the previous efficiency proven on this put up and put all of your eggs in a single basket. Assemble your portfolio correctly.

After getting determined the allocation, it’s essential to choose a momentum index fund or ETF. You’ve gotten 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 deciding on 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 anxious 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 fastidiously earlier than investing.

This put up is for schooling objective 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 should not recommendatory. My views could also be biased, and I’ll select to not concentrate on features that you just contemplate essential. Your monetary objectives could also be completely different. You might have a special threat profile. You might be in a special life stage than I’m in. Therefore, it’s essential to NOT base your funding selections based mostly on my writings. There isn’t a one-size-fits-all resolution in investments. What could also be a very good funding for sure buyers might NOT be good for others. And vice versa. Subsequently, learn and perceive the product phrases and circumstances and contemplate your threat profile, necessities, and suitability earlier than investing in any funding product or following an funding strategy.