Want to Outperform the Market? Learn How Momentum Investing Drives Alpha!

What is momentum investing?

Just like a pendulum, a momentum strategy believes that the price of a particular asset will continue to move on the same trajectory for some time. If the price of an asset has been moving positively, i.e., increasing for a certain amount of time, then the price momentum will continue in the same direction for a longer period of time. Similarly, on the downside, if prices go in a negative direction, the negative momentum will be sustained for an extended period of time.

A momentum strategy aims to take advantage of these continuous price movements, capture them, and provide an alpha over and above the plain vanilla index investment strategy. Currently, there are around 17 Momentum funds available on NSE. Only one of these funds is actively managed, and the rest are passive funds, consisting of both index funds and ETFs.

Are Momentum Funds useful for short-term or long-term investment?

• Momentum Funds are not beneficial for short-term investment and should be held for a longer time horizon. It is a strategy for long-term investors who want to increase returns by using factor investing, using momentum as a factor for improving alpha.
• The momentum strategy is a way of investing for long-term investors to get additional alpha. In the short term, any kind of investment strategy carries the risk of the market.
• For long-term investors, the momentum investment strategy can give better returns than the underlying index. Momentum investing tends to work better during bull markets and tends to underperform during bear markets.

Considerations before adopting a Momentum investment strategy

1. Decide on the risk profile of your investment. For example, decide whether to invest in large-cap, mid-cap, or small-cap, since each has a different risk-return profile.
2. Second, decide whether to choose a passively managed fund like an index fund or an actively managed fund. In an actively managed fund like a PMS structure, it involves a lot of transactions due to buying and selling of stocks, resulting in more fees in terms of capital gains and transaction costs. Whereas in a mutual fund structure, the tax implication is only on exiting from the fund. Hence, the MF structure tends to be more cost-efficient.

Since Momentum Funds have higher risk, beginners should avoid momentum investing. As per SEBI guidelines of risk scale, these funds have a high level of risk due to high volatility in the returns of these funds. Investors looking to make a quick short-term investment should understand all the risks involved based on their risk appetite.

In conclusion, it is advisable to invest in a Momentum Fund only if investors have a longer-term investment horizon to allow the investment strategy to give the benefit of additional alpha. An alternative investment strategy is to create a satellite investment portfolio with Momentum Funds around the core investment portfolio to keep a balance between risk and return.