Momentum magic

The world can't thank Stalingrad enough. If not for this industrial town in the Soviet Union (now Russia), the very atom of our being would likely be different. Let's time-travel to Stalingrad in the fall of 1942. By then, Nazi Germany had steamrolled its opposition. Until then, the 'greatest army ever assembled' had pantsed the Soviets (just like it had the others), humiliating them on all war fronts. Until Stalingrad struck when their general Georgy Zhukov's counteroffensive to tire the Nazis and encircle them there proved a masterstroke. The Nazis' eventual surrender added a gust of wind to the Soviet's sails. Within a few months, the Soviets had blasted them back to Berlin, with Stalingrad hailed as the turning point. It was here that the Soviets (and their Allies) got the momentum (and belief) to shatter Hitler's imperial designs. In everyday life, momentum is an unstoppable force. It can rage against fate's will and inexplicably bend it for you. In physics, it is a product of mass and velocity. In investing, momentum is a strategy that involves buying companies that have delivered high returns in recent weeks and months. The belief among momentum investors is that growing stocks will continue to perform well in the near future. But momentum investing is like 'catching lightning in a bottle'. Recognising companies that have caught momentum and are likely to ride the wave in the short term is fraught with risk, at least for an individual investor shackled by time and knowledge. And so spawned momentum indices - and the mutual funds that track them. Introducing momentum funds Momentum is a theme that has turned heads recently. If you look at the oldest momentum index launched more than three years back - the Nifty 200 Momentum 30 TRI - its investment pool covers the 200 largest companies by market capitalisation. While, in theory, the larger companies grow slower, the momentum index has defied such conventions by outstripping even the small-cap index in the last one year - 68.9 per cent versus 63.5 per cent (as of February 29, 2024). And in case you didn't know, small-cap funds have had a memorable last 12 months! Even if you check the Nifty 200 Momentum 30 TRI's returns since inception, the gap between the small-cap index isn't as yawning as one would expect - 30.5 per cent versus 36.8 per cent returns (as of February 29, 2024). Generally, most fund managers would struggle to generate such alpha from investing in just the top 200 companies. But that's the power of momentum. The science behind momentum Going back to Stalingrad, Nazi Germany's meltdown in the biting winter of the Soviet Union can be partly attributed to the fact that their exterior defensive lines were mainly composed of ill-trained Romanian and Hungarian soldiers. As a result, they could not competently respond to the Soviet counterpunches. The momentum strategy doesn't make the same mistake. It tries to eliminate the weak links as best as it can. If you look at the Nifty 200 Momentum 30 TRI, it scans the 200 largest companies listed in the stock market to identify companies that have consistently performed the best in the last six and 12 months. The less volatile, the better. These stocks then get a momentum score. Based on that, the top 30 stocks make the cut. The weights are then decided based on the momentum score and free float (percentage of the market capitalisation held by the public). This process is repeated every six months. Momentum funds in small-cap clothing Even though Nifty 200 Momentum 30 TRI can only invest in the 200 largest companies, its returns are almost comparable with the small-cap index Momentum fund (in %) Small-cap funds (in %) Last 12 months 68.9 63.5 Since inception of momentum funds 30.5 36.8 Note: Returns are as of February 29, 2024 If you think you can mimic the index on your own, you are in for a big surprise. The momentum index replaces 50-67 per cent of the constituents every six months. That's a lot of monitoring and buying and selling for an individual. Also, the momentum index is not bulletproof. It runs the risk of choosing stocks that may lose momentum in the next six months. The sloppy six These six companies ended up lagging the most during their brief stay in the momentum index Company Period Stock returns (%) Market returns (%) Average allocation (%) Bharat Heavy Electricals Jun-21 to Dec-21 -17 22 0.8 Cholamandalam Investment and Finance Mar-21 to Dec-21 0 45 2.4 Mahindra & Mahindra Financial Services Jun-23 to Dec-23 -6 35 2 NMDC Jun-21 to Dec-21 -27 22 1.6 Syngene International Jun-23 to Dec-23 -3 35 1.3 Tata Steel Mar-21 to Dec-21 0 45 5.7 Note: Market returns are of Nifty 200 TRI, the base index for momentum index. Period under consideration is since the launch of the oldest momentum fund in March 2021. But if it works out, the rewards are unlimited. And it's not just in bull markets. During bearish phases, too, this strategy invariably picks stocks that are falling the least. The super six These six stocks were part of the momentum index and gave more than 100 per cent returns than the market Company Period Stock returns (%) Market returns (%) Average allocation (%) Adani Enterprises Mar-21 to Jun-23 180 51 5.2 Bharat Electronics Dec-21 to Jan-24 171 46 3.5 Hindustan Aeronautics Jun-22 to Jan-24 217 65 3.7 Power Finance Corporation Jun-23 to Jan-24 202 43 5 REC Jun-23 to Jan-24 255 43 4.5 Trent Jun-22 to Jan-24 178 65 3

This article was originally published on March 15, 2024.