If you want momentum, this is the strategy that works best!

Summary: Momentum funds look exciting, but one of them has quietly outperformed its rivals for years. Curious which momentum index topped the charts and why it works the way it does? Read on.

Make no mistake, momentum investors have had a difficult year. The major momentum indices slipped between 6 and 8 per cent over the last 12 months, which makes it easy to wonder whether the whole strategy has lost its charm. But short-term returns rarely tell you what you are truly betting on. Momentum is not a one-year experiment. It is a long-term belief in strength, in persistence and, in many ways, in India’s own growth journey.

India’s economy is expanding. More companies are scaling, more sectors are maturing and more mid-sized businesses are becoming national leaders. Momentum quietly captures this rise because it simply follows the stocks that are already reflecting the country’s progress. Investing in momentum is, in a sense, investing in the unfolding growth of India itself. And when you view the strategy through that lens, the long-term picture looks very different from the past year.

Take the last 15 years. The Nifty Midcap 150 Momentum 50 Index has delivered an average three-year return of 23.6 per cent. It has also beaten its parent mid-cap index more consistently than any other momentum universe. For anyone who wants to follow momentum in its cleanest form, this is the strategy that has stood tallest.

Of course, momentum is not a bed of roses. It rewards those who remain steady during rough spells.

But first, what is momentum investing?

Momentum lives in the simple idea that stocks that have risen recently can continue to rise. To decide which stocks qualify as winners, these indices look at how much each stock has gained over the past six and 12 months. There is no forecasting and no attempt to guess the next big theme.

In India, this idea takes shape through three pure momentum indices:
• Nifty 200 Momentum 30. This selects 30 winners from both 200 large and mid-sized companies.
• Nifty 500 Momentum 50. This searches for 50 companies across the entire market that comprises 500 companies.
• Nifty Midcap 150 Momentum 50. This focuses on 50 mid-sized companies alone.

Why midcap momentum works best

One of the most useful ways to study long-term performance is through five-year rolling returns. Rolling returns show the average return across many overlapping five-year periods and help you see how an index behaves through different phases.

Here is the comparison.

As you can see in the table above, the mid-cap momentum index leads on almost every measure. It delivers the highest average five-year return. It outperforms its parent in every single period. And it shows a very impressive share of healthy outperformance in the 4 to 8 per cent range. When you combine that with its average three-year return of 23.6 per cent, the message feels almost conclusive. If you want pure momentum, the mid-cap momentum index has been the strongest performer over long stretches of time.

However, this strength has a context that is important to acknowledge. Momentum looks particularly strong over three and five-year periods because the past few years have coincided with a bull run. Several sectors have expanded rapidly and mid-sized companies, in particular, have grown into national champions. Momentum naturally captured this strength because it simply followed stocks that were already displaying it.

What are the risks of momentum investing?

Every strategy has its limits, and so does momentum investing.

Momentum is at its best in a rising market and it often struggles when markets begin to drift sideways or turn down.

The market correction in 2024 is a good reminder of this. During that period, the three momentum indices lost between 29 and 42 per cent from their respective peaks. The Nifty 500 Momentum 50 fell the most and the Nifty Midcap 150 Momentum 50 fell the least. These are stark numbers and a reminder that momentum indices can be prone to corrections and downswings.

So, let’s look at how volatile momentum investing can be. For this, we looked at standard deviation. For the uninitiated, it simply tells you how bumpy an investment’s returns can be.

Unsurprisingly, mid-cap momentum swings more than large-cap-based momentum strategies. But what’s surprising is that the mid-cap momentum index is slightly less volatile than the normal mid-cap index.

Another measure to look at is downside capture. This tells you how much the index tends to fall when its benchmark falls. On this front too, mid-cap momentum usually falls less than the Midcap 150 index because it filters out weaker stocks. That does not mean it escapes declines. It still falls, and on difficult days it can fall sharply, but it falls less than its parent index.

Then, there are the losing years. Momentum does go through negative one-year periods. These happen less often than in the parent index, but they are part of the experience.

Last but not least, most of the performance you see for momentum indices comes from backtested results. Backtests apply the rules to past data and show how the index would have behaved. They assume that every trade is executed perfectly, with no costs and no delays. However, real funds do not have that luxury. They face trading costs, rebalancing challenges, liquidity issues and some deviation from the index. Because of this, real-world returns will always be lower than the index numbers.

The takeaway

Mid-cap momentum is the strongest pure momentum strategy available today. It has delivered the highest average returns and the most consistent outperformance. For investors who want a momentum allocation, this is the strategy with the best historical record.

But like many things that work in markets, momentum demands patience, composure and a willingness to stay invested when the strategy goes through difficult periods. It fits best as a small satellite part of a portfolio, something in the range of 5 to 15 per cent, supported by a steady core of broad equity funds.

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Also read: Is Nifty mid-cap momentum index a smart bet?