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 accomplished properly just lately. Therefore, I’m not stunned to see the AMCs launching completely different variants of momentum merchandise.

Should you imagine in momentum investing, which variant of momentum will you decide? You may 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 imagine 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 preserve rising or till you’ll find 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 most effective 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 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 range. As an illustration, NiftyIndices, amongst different issues, considers value efficiency over the past 6 and 12 months. S&P, however, considers the efficiency of the final 12 months, excluding the latest 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 vital. 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. 

Think about 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 could have the next 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 vital too however you possibly can learn the detailed methodology in this doc.

Inventory weight is capped at decrease of 5% or 5 occasions 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 properly within the backtest information. If the issue index has not accomplished properly 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 could be good, in any other case the AMC wouldn’t launch the index fund and I wouldn’t be penning this submit right this moment.
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, 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 accomplished properly in backtests and continues to go properly going ahead, you possibly can anticipate 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 need 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 doable that the issue technique could underperform going ahead. Once more, no certainty about something. Nonetheless, you should permit this possbility whereas deciding the guess measurement.
7. I wrote a submit just lately the place I in contrast the efficiency of varied issue indices because the launch towards their respective benchmark universe. An element index fund which did expectionally properly within the backtests underperformed massively after the launch of the index.
8. No funding technique, irrespective of how good, will do properly on a regular basis. It would undergo durations of underperformance. It’s completely regular. In truth, such durations of underperformance often is the supply of alpha of any funding technique over the long run. As an illustration, if fairness markets did higher than financial institution mounted deposits on a regular basis, then everybody would spend money on shares and nobody would spend money on financial institution mounted deposits. Regularly, the shares costs could be bid excessive sufficient that alpha vanishes.
9. Once 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 occasions. Keep in mind, funding returns may 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 could not have very excessive liquidity. Whereas the index suppliers attempt to deal with such points (by stopping very heavy allocation to smaller shares), we are able to’t fully ignore this issue. Mentioned this facet in my submit on equal weight indices.

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

I evaluate 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 12 months Returns

Momentum Indices: Rolling Returns

Momentum indices have accomplished fairly properly on the rolling returns entrance too. This isn’t shocking given the large outperformance within the CAGR over the long run.

Momentum Indices: Volatility and Most Drawdown

Alongside anticipated strains. You’d anticipate momentum indices to be extra unstable and present greater drawdowns than Nifty 50.

Momentum Indices: Efficiency throughout varied market phases

I in contrast the efficiency of varied momentum indices over completely different market phases. Throughout varied 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.  Apart from minor underperformance when Nifty has returned lower than 10%, the momentum indices have accomplished higher throughout all different market phases.

Which Momentum index do you have to spend money on?

Earlier than you get there, you should first resolve whether or not you should spend money on any momentum index. Previous efficiency seems nice however there isn’t a assure that this efficiency will maintain. Any technique goes via 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 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. Assemble your portfolio properly.

After you have determined the allocation, you should decide a momentum index fund or ETF. You may 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 take a position (from a set of comparable funds/methods), I would favor to see how these indices carried out throughout hostile market phases. Would favor the one which retains me rather less fearful throughout dangerous market phases. Helps me in sustaining funding self-discipline and that’s additionally the important thing to funding success.

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 fastidiously earlier than investing.

This submit is for schooling function alone and is NOT funding recommendation. This isn’t a suggestion to take a position or NOT spend money on any product. The securities, devices, or indices quoted are for illustration solely and aren’t recommendatory. My views could also be biased, and I could select to not deal with facets that you simply take into account vital. Your monetary objectives could also be completely different. You might have a distinct threat profile. You might be in a distinct 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 answer in investments. What could also be an excellent funding for sure buyers could NOT be good for others. And vice versa. Due to this fact, learn and perceive the product phrases and circumstances and take into account your threat profile, necessities, and suitability earlier than investing in any funding product or following an funding method.