Momentum funds attract attention with high returns and low costs but come with unique risks for investors.
Source and citation: “Momentum Funds with 4x Rise in Assets in a Year a ‘Long-term Option’ for Now,” Prashant Mahesh, ET Bureau
TLDR For This Article:
Momentum funds have seen a significant surge in assets due to strong performance and rule-based investing, but they might not continue their outperformance in the near future, according to some experts.
Analysis of this news for a layman:
Momentum funds have been in the spotlight recently because they delivered fantastic returns in the last year, much better than some traditional indices like Nifty 50. These funds follow a “momentum” strategy, which is all about investing in stocks that are currently on a strong upward trend. Essentially, they “ride the wave,” hoping these stocks will keep rising for a while.
Unlike actively managed funds, where a manager picks stocks based on their analysis, momentum funds use a formula to pick stocks showing strong price movement. This makes them “smart beta” funds — a mix between passive index funds and actively managed funds. Popular examples are the Nifty 200 Momentum 30, which picks the top-performing stocks from the Nifty 200 based on momentum, and other variations that focus on mid-cap and multi-cap stocks.
The surge in assets — from ₹3,500 crore to over ₹15,000 crore — suggests that investors are excited about the returns and like the idea of a rules-based, no-bias approach to stock selection. However, financial experts warn that momentum strategies might not always work, especially if market trends change.
Impact on Retail Investors:
- Potential for Higher Returns: The strong performance of momentum funds has been appealing, but investors should understand that these returns are based on market trends, which can be unpredictable.
- Low Fees, High Interest: Momentum funds have relatively low expense ratios, making them cost-effective for retail investors who don’t want to pay high fees to fund managers.
- Market Timing Risk: Momentum investing works well in trending markets but can lead to losses during sudden market reversals or high volatility, which can be risky for retail investors who are not well-versed in market cycles.
- Diversification and Strategy Understanding: It’s crucial for retail investors to know that while momentum funds offer a different strategy compared to value or growth funds, they should be seen as a part of a diversified portfolio, not as a standalone investment.
Impact on Industries:
- Asset Management Companies (AMCs): Companies like HDFC AMC, Nippon India AMC, UTI AMC have introduced momentum-based funds. The rapid growth of these funds enhances their total assets under management (AUM), but performance volatility could impact their growth and customer satisfaction.
- Stock Market Brokerages: The increased interest in momentum funds can lead to higher trading volumes, benefiting brokerages like Zerodha, ICICI Securities, Angel One. However, this surge is largely trend-dependent, and brokerages could face revenue challenges if interest in momentum strategies wanes.
- Tech & Finance Sectors: Since momentum funds rely heavily on stocks that perform well in short periods, sectors like technology, finance, and consumer discretionary are often preferred. Companies in these sectors that display strong short-term performance, such as Infosys, TCS, HDFC Bank, Bajaj Finance, might see increased buying from these funds.
Long Term Benefits & Negatives:
Benefits:
- Rule-Based Investment Appeals to Investors: The lack of human bias is a major draw, offering transparency and consistency in stock picking.
- Potential for Outperformance: If market trends remain favourable, momentum funds could continue to outperform traditional indices, making them a strong option for investors seeking growth.
Negatives:
- Volatility Sensitivity: Momentum strategies can be highly sensitive to market conditions, potentially leading to significant losses during downturns or market corrections.
- Risk of Trend Reversals: A key risk is that when a trend reverses, momentum funds might underperform significantly, which is something retail investors need to be cautious about.
Short Term Benefits & Negatives:
Benefits:
- Strong Short-Term Returns: In a trending market, momentum funds can deliver high returns, as demonstrated over the last year, which makes them attractive for investors looking for quick gains.
- Diverse Exposure to Leading Stocks: With different variants like large-cap, mid-cap, and multi-cap, investors get diverse exposure to top-performing stocks across market segments.
Negatives:
- Challenging Market Timing: These funds might be less effective in volatile or range-bound markets, where price trends are not clear, potentially impacting returns.
- Risk of Overconcentration: Since momentum funds tend to focus on stocks with strong performance, there might be a risk of overconcentration in certain sectors or stocks, leading to heightened risk if those sectors face downturns.
Analysis of Impact of Momentum Funds’ Growth
Indian Companies Impacted
Companies that could potentially benefit:
- Asset management firms: Firms offering momentum-based strategies could see increased inflows and higher revenues. Examples include ICICI Prudential Mutual Fund, HDFC Mutual Fund, and Axis Mutual Fund.
- Index providers: Companies providing indices used for momentum strategies could benefit from increased demand for their products. Examples include NSE Indices and BSE Indices.
- Technology providers: Firms offering technology solutions for momentum investing, such as data analytics and portfolio management tools, could see increased business. Examples include Quantifi, RiskEdge, and Algorithmics.
Companies that could potentially be negatively impacted:
- Traditional fund managers: While the impact might be limited, traditional fund managers could face increased competition from momentum strategies, especially if they underperform. Examples include Reliance Mutual Fund, SBI Mutual Fund, and Franklin Templeton Investments.
- Market cap-weighted index funds: As momentum strategies focus on stocks with strong price momentum, market cap-weighted index funds could see reduced inflows. Examples include Nifty 50 Index Fund and Sensex Index Fund.
Global Companies Impacted
Companies that could potentially benefit:
- Global asset management firms: Global firms offering momentum strategies could see increased demand from Indian investors seeking international exposure. Examples include BlackRock, Vanguard, and State Street.
- Global index providers: Global index providers offering momentum indices could benefit from increased demand from Indian market participants. Examples include S&P Dow Jones Indices and FTSE Russell.
Companies that could potentially be negatively impacted:
- Global traditional fund managers: While the impact might be limited, global traditional fund managers could face increased competition from momentum strategies, especially if they underperform. Examples include Fidelity Investments, T. Rowe Price, and Invesco.
Note: The actual impact on these companies will depend on various factors, including their business model, market positioning, and ability to adapt to changing investor preferences.