White-hot momentum funds face reality check after market turns red

A day is a long time in the equity market; a month is like an era. Momentum funds are finding this the hard way.

On a moonride and in white-hot demand until the last week of September, momentum funds crash-landed in October as the broader equity market turned red.

The Nifty 200 TRI has fallen 9.9 per cent since September 26, while momentum-based indices have tanked up to 12.1 per cent.

Why are momentum funds falling more?

Let's first understand how momentum funds select their stocks. This will explain why they have fallen harder in the last few weeks.

Momentum funds invest in stocks with strong recent performance. Their goal is to capitalise on red-hot market trends.

Although this strategy worked out well for investors during the market upswing following Covid, the recent pullback in the equity market has sucked the energy out of these funds.

Layer upon the fact that momentum funds tend to have concentrated portfolios (read: invest in fewer stocks). In such cases, the presence of a few bad apples (stocks) can spoil the barrel (overall performance).

Our take

The recent correction sheds light on the fragility of momentum funds.

Such funds can produce strong performances in bull markets but cannot offer a lot of downside protection during market downturns.

Which is why diversified mutual funds ( flexi-cap and multi-cap funds ) can be a better option. They offer wealth-creation potential, stability and broader market exposure compared to narrow, momentum-driven strategies.

Also read: Great funds for a volatile market