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

In the event you imagine in momentum investing, which variant of momentum will you choose? You’ve got atleast 3 decisions of momentum indices now.

On this put up, let’s see how these momentum issue indices have carried out prior to now.

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 latest 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 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 Greater.

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

As an 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 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 fluctuate. As an example, 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 latest 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) is predicated on latest 6-month and 12-month value return, adjusted for volatility. Adjustment for volatility is vital. This ensures that extra risky shares get decrease scores. Thus, even in a momentum portfolio, the desire is in 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 could have a better momentum rating because it was much less risky 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 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 completed fairly properly within the backtest information. If the issue index has not completed properly prior to now, it wouldn’t discover many takers on the availability aspect (AMCs) or on the demand aspect (traders).
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 at present.
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. As an example, 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 completed properly in backtests and continues to go properly going ahead, you possibly can count on traders to pile in some huge cash into that technique. Because the funds circulation 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 do this however you have 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 any assure that such alpha will maintain sooner or later. It’s potential that the issue technique might underperform going ahead. Once more, no certainty about something. Nevertheless, you have to permit this possbility whereas deciding the guess measurement.
7. I wrote a put up just lately 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 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 intervals of underperformance. It’s completely regular. In reality, such intervals of underperformance will be the supply of alpha of any funding technique over the long run. As an 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. Step by step, the shares costs can be bid excessive sufficient that alpha vanishes.
9. Once you spend money on 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 fallacious occasions. Bear in mind, funding returns may 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 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 will’t utterly 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 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 completed fairly properly on the rolling returns entrance too. This isn’t shocking given the vast outperformance within the CAGR over the long run.

Momentum Indices: Volatility and Most Drawdown

Alongside anticipated traces. You’ll count on momentum indices to be extra risky and present larger drawdowns than Nifty 50.

Momentum Indices: Efficiency throughout varied market phases

I in contrast the efficiency of assorted momentum indices over totally 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 kind of spectacular.  Aside from minor underperformance when Nifty has returned lower than 10%, the momentum indices have completed higher throughout all different market phases.

Which Momentum index do you have to spend money on?

Earlier than you get there, you have to first determine whether or not you have to spend money on any momentum index. Previous efficiency appears to be like nice however there isn’t a assure that this efficiency will maintain. Any technique goes via intervals of underperformance or outperformance. You could have conviction to stay with the technique throughout poor phases.

Do you imagine in momentum investing?

In the event you don’t, then you have to not spend money on momentum index funds.

In the event you do, then you have to determine 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.

Upon getting determined the allocation, you have to choose a momentum index fund or ETF. You’ve got 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 favor to see how these indices carried out throughout opposed market phases. Would favor the one which retains me rather less frightened throughout dangerous 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 by no means assure efficiency of the middleman or present any assurance of returns to traders. Funding in securities market is topic to market dangers. Learn all of the associated paperwork fastidiously earlier than investing.

This put up is for training function alone and is NOT funding recommendation. This isn’t a suggestion to speculate or NOT spend money on 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 concentrate on facets that you simply contemplate vital. Your monetary targets could also be totally different. You’ll have a special danger profile. You could be in a special life stage than I’m in. Therefore, you have to 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 funding for sure traders might NOT be good for others. And vice versa. Subsequently, learn and perceive the product phrases and circumstances and contemplate your danger profile, necessities, and suitability earlier than investing in any funding product or following an funding strategy.