Why momentum investing is not for all

Indian equity investors will soon get a taste of momentum investing. UTI Mutual Fund has filed papers for a first-of-its-kind offering, UTI Momentum Index Fund. Should you get onto the momentum investing bandwagon that has been a phenomenal success in recent years?Chasing pricesMomentum investing essentially involves buying winners and selling losers. In other words, buying stocks that have been performing the best while weeding out recent laggards. Cut your losses and let your winners run. It is based on the premise that stocks that have gone up (or down) in the recent past will continue to go up (or down) in the near term. As Vidya Bala, Head – Research, Primeinvestor.in, points out, “Capturing momentum is all about riding an established trend.” This approach is diametrically opposite to value investing—a philosophy that has gained much more prominence. In value investing, investors prefer stocks that are currently trading below their intrinsic value and may have fallen out of favour. The premise here is that since the stocks are already trading at low prices, they offer better margin of safety while potentially offering higher upside over the long run. Momentum investing upends this philosophy to suggest that buying stocks that are in vogue will deliver best results in the near term. It encourages more short-term thinking than the traditional long-term ‘buy and hold’ approach. 78331596Does it work?The numbers speak for themselves. For investors in India, momentum has enjoyed a solid run for over a decade now. The Nifty200 Momentum30 index, which comprises 30 stocks that have delivered highest outperformance has comfortably outperformed the frontline Nifty50 index across time frames. Over the past decade, the Nifty200 Momentum30 index has delivered 14.5% annualised returns even as the Nifty50 index has yielded 6.5%. Over the past five years, the momentum-based index has clocked 13.5% relative to the 7.6% annualised returns of the Nifty50 index. Clearly, the momentum-driven approach has demonstrated outperformance. Existence of momentum is considered a well-established empirical fact with evidence dating back more than 200 years in the US markets. This hard data predates many of the other established investing philosophies. Bala asserts, “Momentum strategy is a tactical ploy in times of a narrow market breadth, as it makes picking stocks easier when company fundamentals do not provide any answers.”Yet, this strategy has not received acclaim among the wider investor community. Unlike the religious following of value investing, this investing style remains on the fringes despite strong evidence in its favour. It remains an alien concept among common investors in India. Arun Kumar, Head – Research, FundsIndia, explains, “Despite being a proven concept, momentum has not gained currency as it involves a lot of churn. Mutual funds have not been able to crack it as this strategy cannot be scaled up at higher base without the incidental costs.”However, this strategy is harnessed effectively by savvy investors. In fact, several fund managers routinely ride the momentum wave to deliver returns to investors. Most fund managers in the country profess to abide by the ‘growth at reasonable price’ framework—buying stocks that offer high growth visibility without paying through the nose for that perceived growth. This is supplemented with a purported preference for long term. However, many fund managers do have an overlay of momentum in a portion of the fund portfolio. They keep rotating in and out of winners to generate that alpha that investors constantly seek.Is momentum for you?Clearly, there is a strong case for momentum investing. However, investors need to exercise caution. Every investing strategy goes through phases. While momentum has enjoyed a strong run for many years now, it should not be construed as a surefire way to create wealth. It has its flipside. While momentum can outperform spectacularly during a market uptick, it tends to hurt equally on the downside when the market corrects. “Momentum is essentially about chasing prices. The problem with this strategy is you don’t know when the tide will turn,” says Vikas Gupta, Chief Investment Strategist, OmniScience Capital. By the time a downtrend is captured, the damage may already be done.Data from Capitalmind reveals that a simple momentum strategy yielded 139% return in 2007 and 108% in 2017 when the Nifty50 index only gained 53% and 28% respectively. On the other hand, the momentum strategy registered a loss of 78% in 2008 when the Nifty50 tanked by 51%. While it visibly outperforms over longer time frames, the outperformance comes at the cost of higher volatility and larger drawdowns in the short-term. Investors who cannot stomach this volatility may find it unsuitable.Experts insist momentum by itself is a risky play, without the backing of fundamentals. Gupta remarks, “The basic flaw in this strategy is that it ignores fundamentals. You keep buying at elevated prices but it will not be long before you find that the emperor was not wearing any clothes.”Graphics by Abdul Shafiq/ET Prime

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