Is it Possible to Engage in Momentum Investing Using Mutual Funds?

There are a plethora of different techniques and investment strategies that you can use in the Indian stock market to ensure consistent wealth creation. One of the many different strategies that you can use is momentum investing. With the momentum investment strategy, you can capture short-term price movements in a wide range of assets, including mutual funds.  

Some mutual funds are tailor-made for momentum investment strategies. These funds are also referred to as momentum funds. Wondering what this strategy is and what makes it so special? Read on to find out all about it and whether it is a good mutual fund strategy or not. 

What is Momentum Investing? 

Momentum investing is an investment strategy that involves choosing assets or securities based on their recent price and performance trends. The idea behind such a strategy is that assets or securities that have performed well in the past will continue to perform the same in the future until there are contrary indications.

Can Momentum Investing Be Used in Mutual Funds? 

Yes, of course. Momentum investing can be used in mutual funds. However, much of the success of the strategy relies on your ability to choose the right momentum-based mutual funds. 

Momentum mutual funds are those that incorporate momentum strategies into their investment approach. Managers of such mutual funds dynamically adjust the asset mix to include securities that exhibit strong positive momentum. Sector-specific and thematic funds naturally exhibit strong momentum characteristics, making it easy to execute momentum investment strategies. 

Once you’ve chosen the right momentum fund, you need to thoroughly assess the fund’s performance over the next few months. Also, look for recent changes in the fund’s asset mix to get an idea of whether the fund manager has taken any steps to include securities exhibiting strong momentum characteristics. Consider investing in the fund only if you notice strong positive momentum in the fund or the assets in its portfolio. 

Once you’ve invested in momentum-based mutual funds, you need to regularly monitor the markets. Also, you need to assess the fund’s performance and keep an eye out for potential trend reversals. If you notice any sudden price trend changes, consider booking profits and exiting the fund.  

Momentum Investing in Mutual Funds – An Example 

Let’s walk through a hypothetical scenario to understand how momentum investing in mutual funds works.

Assume you’re interested in engaging in momentum investing using mutual funds. Aiming to capitalise on the recent uptrend in the energy sector, you choose a thematic mutual fund that invests in the energy sector. The fund’s portfolio consists of some of India’s top traditional and renewable energy companies. The thematic fund uses a dynamic asset allocation strategy that focuses on companies showing strong positive momentum, making it the perfect mutual fund for using a momentum investment strategy. 

Upon analysing the performance of the thematic fund for the past 6 months to a year, you conclude that it has been outperforming the market consistently. Therefore, you invest around 20% of your total investment capital in the fund, hoping to leverage the short to medium-term price movements in the energy sector. To combat the potential risks associated with this momentum fund, you invest the remaining investment capital in a diversified portfolio of safer and low-risk assets. 

As you expected, the energy sector continues its bull run, prompting you to stay invested in the fund. Throughout the investment period, you continue to closely monitor the energy sector trends, the financial performance of the sector stocks, and the fund manager’s updates. 

After about five months from the date of investment in the momentum mutual fund, you notice a slowdown in the positive momentum. The fund manager’s commentary and changes to the asset mix confirm your predictions of an impending slowdown. At this point, you choose to exit by redeeming your investment in the fund. 

Thanks to your timely intervention and a keen eye on market trends, you were able to successfully capture the short-term price movements in the energy sector by using a momentum investment strategy. 

Things You Need to Know Before Engaging in Momentum Investing Using Mutual Funds 

Now that you’re aware of how momentum investing using mutual funds works, let’s look at a few things you need to keep in mind before attempting such a strategy. 

• Investment Strategy and Risk Profile 

The investment strategy of the mutual fund must explicitly focus on a momentum investing strategy. When picking out the right fund to invest in, focus on funds that are sector-specific and thematic since they tend to naturally be more momentum-focused. Also, you should ensure that the risk profile of the fund matches your tolerance level. Most momentum-based mutual funds are high-risk investments, making them more suitable for risk-tolerant investors. 

• Performance History 

It is advisable to always pay thorough attention to the fund’s performance history. Remember, it is crucial to pick funds that have a strong track record of outperforming their benchmark index consistently. Although past performance is not a guarantee that the fund will perform the same in the future, it is a good idea to stick to funds that have done well in the past.  

• Expense Ratio 

Momentum mutual funds often have a high churn rate since fund managers are dynamically adjusting the asset mix to capture short to medium-term momentum in sectors and stocks. The frequent buying and selling of assets can increase costs, leading to high expense ratios. As you may know already, high expense ratios tend to reduce your return on investment. Therefore, it is recommended that you compare the expense ratios of multiple momentum-based mutual funds before investing. 

• Transaction Costs 

In addition to the expense ratio, you also need to account for other transaction costs such as brokerage, taxes and exit load. Exit load is the fee that the AMC levies for redeeming mutual fund units before the expiry of the specified holding period. Fortunately, not all momentum funds levy exit load. If you wish to reduce your transaction costs and keep it to a minimum, consider investing in funds with zero exit loads. 

Conclusion

With this, you must now be aware of how momentum investment strategy in mutual funds works and the various advantages it has. However, it is essential to keep in mind that the strategy also has several risks involved. For instance, momentum investing may not work as you intend when the markets are very volatile. 

Furthermore, since fund managers are actively involved in the decision-making process, you may not get the level of control over investment decisions that you desire. Therefore, before you implement momentum investing in mutual funds, always remember to weigh its pros and cons. This way, you can make more informed investment decisions that are in line with your goals and risk tolerance levels.  

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