Active momentum funds: The newest darling of fund houses?

Momentum investing has been the 'in thing' among fund houses. While passive momentum funds have been the focus until now, with 25 such funds launched since 2021, there's been a shift toward active momentum funds. In fact, both Axis and Union launched their active momentum funds just last month.

So, should you invest in active or passive momentum funds?

Frankly speaking, we don't have a conclusive answer yet.

That's because even the oldest active momentum fund - Samco Active Momentum Fund - is just a year old. In other words, this category is too young to be judged so early.

But since we have reached this point, let's look at this category from a theoretical perspective.

Since passive funds replicate an index's stock composition, there's a likelihood of having low-quality stocks in their portfolios. This, in turn, may weigh down their performance.

For example, some stocks in the Nifty momentum indices, such as NTPC, Power Finance Corporation, Tata Power and Rail Vikas Nigam, are rated only three stars by Value Research, while companies like Bharat Heavy Electricals and NHPC are rated only one or two stars.

By contrast, in momentum funds with active strategies, managers can exclude companies that don't meet their selection criteria, resulting in a higher-quality portfolio.

Performance of active and passive momentum funds

When it comes to near-term performance, the passives have trailed.

Edelweiss Nifty Midcap 150 Momentum 50 Index Fund and UTI Nifty 200 Momentum 30 Index Fund gave returns of 41.4 per cent and 34.4 per cent, respectively, in the last 12 months, compared to their benchmarks' 42.3 and 35 per cent in the same period.

On the other hand, the only active fund with a semblance of some history, Samco Active Momentum Fund launched in June 2023, beat its benchmark (Nifty 500 TRI), 33.5 per cent to 25.6 per cent.

Are their investing philosophies different?

• On paper, both active and passive momentum funds identify and invest in stocks showing a strong price uptick.
  
• However, unlike passive funds, which replicate the stock composition of an index, active funds rely on the fund managers' expertise and in-house investing models to put money across companies. So, their stock-selection picks would vary from fund to fund.
  
• Additionally, unlike passive funds, which typically rebalance semi-annually, active funds have more flexibility as each follows its own rebalancing strategy.

Our take

The performance of momentum funds has been patchy and still at a nascent stage.

Moreover, it is yet to be seen how they fare in prolonged bearish phases.

The recent short-term volatility didn't show them in a good light, though. Funds with momentum strategies saw sharper declines compared to the broader markets.

Therefore, since these funds are fairly young and untested by different market cycles, we suggest you adopt a wait-and-watch policy.

Instead, it may be best to stick to diversified equity funds like flexi-cap funds for now.

If you're still unsure which funds suit you best, consider subscribing to Value Research Fund Advisor. Here, you will get customised recommendations, insights on mutual funds and strategies to help you achieve your financial goals. You can also get a list of the top-rated funds across each category, which will help you make better investment decisions.

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Also read: Momentum and alpha funds: Better than even small-cap funds?