Momentum Investing: Should you buy all those stocks which are going up?

These days investing has become easy; at least that is how a novice would like to believe. Buy any mid cap or small cap stock and it goes up quickly. Many mistake luck with their skills and that can be an invitation to agony. However, that does not mean one should not buy stocks that are in uptrend. After all, we all are here to make money, let us not shy away from this fact. But does that mean buying any rising stock is going to work for you? Let us understand this in a more nuanced manner through the momentum investing style:

Many traders buy stocks that are in uptrend. Some of them face a challenge of exiting these stocks at the right time. Randomly buying and selling stocks can lead to fundamentally questionable stocks entering your portfolio and in the long term eroding your capital pool as stocks prices fall when markets catch up with reality.

Some find this strategy of riding rising stocks too difficult to implement. In a rising market, many stocks go up and that makes traders buy a stock that is going up. Even after buying a stock whose share price is on an upward trend, there are stocks whose share price rise much higher than the stock you have bought. This leads to a situation in which you have to choose between a stock which rises faster as opposed to a stock which rises steadily and rewards you consistently in the long run. This is a tough task for most retail investors. Even if a trader acts right – buys right and upward trending stocks, ride them, and sells them at an opportune time--still the trader faces a major challenge. All his actions lead to a lot of churn in his portfolio. In other words, he gets into too many buy-sell transactions which lead to a lot of transaction costs and short-term capital gains. All these challenges make momentum investing a big task in India for most retail investors.

In the context of these facts, mutual funds can be a good investment avenue for investors who are keen on following momentum investing. Mutual funds have been launching index funds which mimic performance of momentum indices such as the Nifty 200 Momentum 30 index or the Nifty Midcap 150 momentum 50 index. These schemes can be considered by savvy investors as satellite investments, after they have created their core mutual funds' portfolio.

As these are index funds, there is no role of a fund manager. A fund manager has to simply buy all those stocks that are present in the underlying index. The rule-based selection of stocks for index construction does away with all biases. For example, a stock is included in the Nifty 200 Momentum 30 index if and only if it scores high on momentum score arrived at using statistical measures. The stock has to be present in derivatives and weight of a stock gets capped at lower of 5 per cent and five times the weight of the stock in the index based only on free market capitalisation. Also the index is rebalanced twice a year in June and December.

Such a methodology helps to keep emotions away. In the longer term, such indices can outperform mother indices such as the Nifty 200 Index or the Nifty Midcap 150 Index. Of course, investors have to learn to live with bouts of volatility in markets. In the bear phase of the market, these stock portfolios can be butchered badly. But for investors with patience these index funds can generate alpha. For example, the oldest momentum index fund – UTI Nifty 200 momentum 30 index fund has given 33.54 per cent returns in one year ended June 20, 2023 compared to 24.76 per cent given by large cap funds on an average, as per Value Research.

Mutual fund investors keen to restrict their momentum portfolios to primarily large-cap stocks should invest in schemes that track the Nifty 200 Momentum 30 index, and those investors who are comfortable with a mid-cap oriented momentum portfolio can look at index funds tracking the Nifty Midcap 150 momentum 50 index. Investors can also look at the recent New Fund Offer (NFO) of Samco Active Momentum Fund.

All in all, investors should note that momentum strategy works wonders only in the long-term. Also you are better-off investing in these funds in staggered manner through Systematic Investment Plans. It helps you deal with volatility well. Since mutual funds are pass through vehicles, the tax incidence occur only when you redeem units. This is a key reason why you should stay invested for the long-term.

Disclaimer: This report is prepared in his personal capacity and neither the Author nor Money Honey Financial Services Pvt Ltd assumes any responsibility or liability for any error or omission in the content of the article. Investments in mutual funds and other risky assets are subject to market risks. Please seek advice from an investment professional before investing.