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In physics, one defines momentum as the tendency of a moving object to continue moving in the same direction. In Investing terms, it means, if the market has driven the value of a stock up for some time, it will continue to do so for some more time. In simple terms the current return pattern is expected to continue over the next short to medium term.

Momentum is an example of empirical phenomenon and it is fairly widely accepted that momentum works. It is based on the simple principle of “near future mimics the near past”. As it becomes more mainstream, and makes its entry into the playbooks of retail investors in India, here is a look at its ‘perceived’ risk level, launch of the new NSE Momentum Index and subsequently a momentum ETF in the Indian market

Risk premium v/s. Behavioural approach

What makes momentum work in the context of the stock market? Even more important, investors new in this field wish to know that if they are making excess returns using the Momentum strategy, are they taking a higher risk? We think there are two ways to look at this.

The traditional “risk premium” school believes in a stronger form of market efficiency and simply states that the stocks with higher momentum effects are inherently more volatile and riskier and whatever excess returns are achieved are purely a compensation for taking on additional risk.

However, the behavioural school says that “investors are at least temporarily irrational” and “their herd behaviour” will push up the prices of “winners” and drive down the prices of “losers” beyond their intrinsic values. The overshooting will be corrected over time but they exist temporarily. This makes Momentum strategy work, by “delaying” the application of efficient markets.

Launch of the NIFTY200 Momentum 30 Index

Whichever approach we as an investor believe in, Momentum is considered an easy to understand and a popular systematic equity investment strategy. Thinking along the same lines, The National Stock Exchange of India (NSE) launched its new index, NIFTY200 Momentum 30, in August 2020.

This index will track the performance of the top 30 companies within the NIFTY200, selected as per their “normalized momentum score”. The score for each index constituent will be determined based on the 6-month and 12- month price return, adjusted for daily price return volatility. The weight of each stock is based on the factor tilt methodology – the weight is derived by multiplying the free float market capitalization with the normalised momentum score of that stock.

As one can guess from the recent scenario, the NIFTY200 Momentum 30 Index is currently overweight the Consumer Goods and Pharmaceutical sectors and underweight the Financial Services sector. This is because during the first half of 2020, the consumer and pharma stocks witnessed steadily high momentum, as the companies performed relatively well during the pandemic related market volatility. And the scene was quite the reverse for financial sector stocks

Similar to the newly launched NIFTY200 Momentum 30 Index, the S&P BSE Momentum Index has also been around for a while. However, with no index funds available to track these indices, it is not simple for investors to take an exposure using this strategy. The best approach till now has been to track the high momentum stocks on an individual basis, and then include them in one’s portfolio.

Coming soon - UTI Momentum Index Fund

The good news – In September 2020, UTI has filed a prospectus to launch its UTI Momentum Index Fund. This fund will replicate the NIFTY200 Momentum 30 Index. Once SEBI approves, the scheme will be launched.

To invest in a momentum index fund will come with its own set of uncertainties and vagaries too. Typically, both the BSE and the NSE index are set to be rebalanced every 6 months. However, momentum practitioners usually rebalance every few weeks, or at least monthly. This might have an effect on the tracking error as well. Keeping all this in mind, there is no harm to allocate some portion of one’s equity portfolio to this strategy and track continuously.

To leave you with some stats¹ –

For the NSE Momentum 30 index, we might not have much live data so far, but since its launch in 2015, the S&P BSE Momentum Index has shown a return of ~14% p.a., compared to 9.18% for NIFTY 50 TRI (Total returns Index) and 8.32% for NIFTY Midcap 150 TRI

NSE back-tested the entire data set prior to the launch of its Momentum 30 Index. If we compare the performance from 2005 till launch, the NIFTY200 Momentum 30 Index showed a CAGR of ~19% p.a. In comparison, NIFTY 50 showed 13.16% CAGR and 12.81% for the NIFTY 200.

¹Source: Nifty200 Momentum 30 Index Whitepaper