Will UTI MF’s momentum investing foray click?

Mutual funds usually analyse the businesses and financials of companies before choosing the right picks for their portfolios. But a sizeable section of investors also prefers go with the flow. This is called momentum investing. Just about two months ago, the NSE (National Stock Exchange) launched a 30-stock momentum index curated from the Nifty 200 index. UTI Mutual has filed a draft prospectus with the capital markets regulator SEBI for the launch of a ‘UTI Momentum Index Fund.’ Here is what investors must know about the product and the underlying concept.

Momentum investing is about buying stocks that have done well in the recent past. Fund managers would typically invest in stocks that have moved up considerably in the recent past—say six months—hoping that the momentum would continue for a short timeframe. When the price of the stock starts to decline, it is sold and is replaced with another that is seeing a sharp upswing. The concept is relatively new in India. In the US, ‘Momentum ETFs’ have approximately $14 billion in assets under management as of June 2020.

The ‘UTI Momentum Index Fund’ is based on the ‘Nifty 200 Momentum 30 index.’ The index aims to track the performance of the top-30 companies within the Nifty-200, which are selected based on their normalised momentum scores. Nifty 200 is the parent index with stock weights in the momentum index capped at 5 per cent or five times the weight of the stock in the Nifty 200 index, based on free-float market capitalisation.  The normalised momentum score for each company is determined based on its six-month and 12-month price returns, adjusted for volatility.

Capturing momentum is all about riding an established trend. This approach is diametrically opposite to value investing—where you buy stocks that are currently trading below their intrinsic value and may have fallen out of favour. Momentum investing is based on short-term thinking rather than the traditional ‘buy and hold’ approach.

So far, the Nifty 200 Momentum 30 index has done well. The index has outperformed the Nifty 200 since inception, with an 18.6 per cent CAGR return, as against 12.7 per cent return for the Nifty 200 Index. In the last three years, the Nifty 200 Momentum 30 Index has given a 7.2 per cent CAGR compared to 4.3 per cent CAGR for the Nifty 200 Index. The ‘Momentum 30 index’ has outperformed its parent in 13 out of the last 16 calendar years.

Historically, for a five-year investment horizon, based on daily rolling returns, the Nifty 200 Momentum 30 Index has outperformed the Nifty 200 Index, 98.3 per cent of the time.

Based on daily rolling return analysis, the index has outperformed the Nifty 200 index, 78.7 per cent of the time, during the one-year timeframe. “It is a good option for aggressive investors because resetting of portfolio happens every six months,” says Rupesh Nagda, founder, Family First Capital, a financial services firm. “They (fund managers) are not going to sit on a stock that has been underperforming,” he says. “It (momentum investing) works well for aggressive investors,” says Srikanth Bhagavat, managing director, Hexagon Capital Advisors.

Experts advise caution and insist that momentum by itself is a risky play because it does not look at fundamentals and that investors should not get carried away by past returns. “Momentum (investing) has enjoyed a strong run for many years but is not a sure-fire way to create wealth,” says Raj Khosla, managing director, MyMoneyMantra.com.

Replication of the momentum index would require robot-like discipline. The tax outgo and brokerage for such investing is significant since churning of portfolios happens at regular intervals. For instance, the automobile sector had 17.1 per cent weight at the end of December 2017, but this reduced to zero at the end of 2018. Although investing through a mutual fund saves you from paying taxes and brokerage costs, it remains to be seen how efficiently the UTI scheme would be able to track the benchmark index, the impact cost every time it buys and sells and tries to mimic the index and the tracking error.

“It (momentum investing) involves a lot of churning of the portfolio. Mutual funds have not gone for it because it involves higher costs, with bigger teams and the need for constant research,” Khosla says. Equity funds can pass on the brokerage costs of only up to 12 basis points as part of the scheme’s total scheme ratio.

A momentum investing strategy is a highly risky one. “Investors should look at multiple factors such as earnings and value among others before deploying their money. When you invest in something that is based on a single factor (such as momentum), your portfolio could significantly underperform at certain inflection points in the market,” says Anil Ghelani, head of passive investments, DSP Investment Managers. “It would take a long time for them to catch up after any sharp underperformance,” he says.

“When there is a big bear market, these stocks would underperform. Funds that invest in momentum stocks could also have high tracking error, as it would be difficult to capture the sudden steep changes in prices,” Nagda says. “The fall would be more severe in momentum stocks when there is a sharp correction in the markets,” Bhagavat says.

Investment advisors and experts believe that momentum funds or stocks should not have more than 5 per cent weightage in the portfolio of average investors. Momentum stocks also tend to be slightly more volatile than the regular ones. The ‘Momentum 30 index’ has been more volatile over long-term horizons.

Watch this space for more as and when the UTI Momentum Index Fund is rolled out.