There has been an increase in the variety of equity offerings in the mutual fund industry lately.
This has been advanced by several factors like :
· Increase in Inflow
· Growing market sentiment & Retail Exposure
· SEBI’s re-categorization exercise
Increasing retail exposure has meant that investors are now more aware about mutual funds in general, this has led to higher expectations with regards to product offerings.
SEBI’s re-categorization exercise has also meant that AMC’s now cannot have more than one active fund in a category except for thematic funds.
All of the aforementioned points have resulted in mutual fund companies looking for newer products to penetrate the retail space even further while staying in compliance.
The recent influx of momentum funds in a short space of time is a result of that.
What is a momentum mutual fund?
Momentum mutual funds follow the investing strategy of momentum investing.
The basic premise of such a philosophy is that stocks that have been on a rise recently will continue to do so.
So a momentum mutual fund basically tries to capture that momentum.
This is contrarian to the otherwise popularly and recommended buy and hold school of thought.
Considering the points under consideration as well as the time at play, it is better to view it as a trading chapter than an investing book.
Whether the chapter should be skipped or is worth a read depends entirely on the type of reader (Investor in this case).
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Difference between a Momentum & a Traditional Equity Fund
Features of Momentum Mutual Funds
Momentum mutual funds focus more on recent winners as opposed to long term bets and they do so by aiming to maximize the recent upswing.
There is a greater emphasis on quantitative analysis over fundamentals which makes sense considering the duration at play is short to medium term.
At present most momentum mutual funds in India are actively managed.
Valuations and Fundamentals take a back seat since the basic premise is of short-term gains and not long-term bets.
Pros & Cons of Momentum Mutual Funds
PROS
Diversification
Most equity funds can be divided broadly into the growth or value school of investing.
Sure there are other factors at play like sectors, market caps, number of holdings, etc. but momentum as a factor is rarely employed by equity mutual fund schemes.
Momentum mutual funds therefore truly provide diversification to your mutual fund portfolio.
Probability of Higher returns
Momentum mutual funds hold the probability of higher returns comparatively since they seek stocks that are on the rise.
There is of course no guarantee of perpetual rise and therefore higher returns but the possibility exists.
Momentum mutual funds also tend to do better in bull markets as opposed to bear markets.
Eliminates Human biases
Humans are inherently emotional and bias is an aspect of that.
Momentum investing eliminates that since the are no preferences to sectors, market caps, themes, etc.
As expected, momentum is at play so whichever stocks are not only on the rise but also show enough to continue the rise will be preferred irrespective of their sectors, market caps, etc.
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CONS
Higher Volatility
Investors are often lured by the potential of high returns by momentum mutual funds but conveniently ignore that the potential arises due to its volatile nature.
Momentum mutual funds also tend to underperform in bearish or sideways markets, this may seem as a given since it is equity after all but the fall may be steep and longer than traditional equity mutual fund schemes.
Requires Timing
An approach such as momentum investing requires extensive research and impeccable timing.
This is because not only do you have to pick a stock that has done well recently, it also needs to continue to do well in the short run.
One needs to be careful not to zero in on a stock whose growth has plateaued.
Trends also are short lived, if anything exceeds a significant amount of time then it ceases to be a trend.
Therefore, one needs to enter and exit at a time that is beneficial but that is always not possible and the downside can be brutal.
Difference between Momentum Indexes and other Indexes
A momentum index fund and a traditional index fund are poles apart for the following reasons:
Sensex as an example has stocks selected on the basis of their market capitalization and liquidity.
Most of these are giants and leaders in their respective sectors.
Then there’s the Nifty 500 benchmark that has the top 500 stocks based on market caps, in a way you could say it encapsulates the Indian economy.
None of the above points are applicable to a Momentum Index Fund.
Indexes are usually juggled every 6 months, in June and December but here is where it gets interesting.
When indexes are juggled the changes are minor in terms of entry and exits but with a momentum index fund the change can be drastic to the point that more than half of the index can be changed in a day.
This is because momentum investing relies on trends and trends are always on borrowed time with a limited shelf life.
It would not be far-fetched to view a momentum index fund as more of an active fund than a traditional equity index fund.
A momentum index fund does not work like a traditional equity index fund.
Should you invest in Momentum Mutual Funds?
Let’s make one thing very clear, this should not make up a major chunk of your portfolio nor should it be the sole mutual fund scheme.
This is something that can be used for diversification if you feel you have utilized the vanilla portion of your mutual fund portfolio.
Ironically even though momentum investing strategy applies a very short term strategy, as an investor it only makes sense if you have to ability to hold momentum mutual funds for a very long time.
The real gain of momentum mutual funds is only at play if this contrasting approach to holding by both the fund and investor is in effect.
A momentum mutual fund can used as a blend and addition to your core mutual fund portfolio as long as you have the stomach for volatility more so during bearish phases.
The fund can be quite rewarding as long as both your head and heart work together and not in isolation.
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