By Chintan Haria, Head – Product Development & Strategy, ICICI Prudential AMC

When it comes to investing in equities, there are various styles of investment. Over a complete market cycle, there will be phases when each style will have its time under the sun. Banking on a stock that has outperformed the broader market indices in the belief that it may continue its outperformance till the trend is not broken, is the basic tenet of the momentum-based investing approach. There is a saying among technically savvy investors in the market – ‘trend is your friend except at the end where it bends’. This aptly applies to the concept of a momentum-driven investment approach.

Interestingly, the ability of momentum strategy to generate an excess return is described as a ‘premium anomaly’ by Eugene Fama, the father of the Efficient Market Hypothesis. One of the possible reasons why the momentum strategy is able to generate excess return can be the fact that the investors tend to initially under-react to the news affecting the stock prices. Thus, the news gets reflected in the stock prices gradually and not instantly.

In the momentum-based investing style investor tries to capitalise on the continuance of the current trend with the aid of a strict set of technical indicators that dictates the entry/exit points of a stock. The investor here benefits from staying with the trend until the conclusion, no matter how long it lasts. Also, the investor benefits from market volatility by taking positions in a stock going up and selling them on the signs of tapering-off, moving the capital to new positions.

Based on this rule, index providers have introduced the momentum strategy index. For example, The Nifty 200 Momentum 30 index, comprises stocks with a high normalised momentum score. This momentum score is computed based on the 6-month and 12-month price return, adjusted for its daily price return volatility, and weights in the index are derived from multiplying the free float market cap with the normalised momentum score of the stock. The constituents of the index are reviewed twice a year for rebalancing.

To enter the momentum 30 index, a stock should be part of the NSE 200 index, with minimum one-year listing history, and it should be trading in the F&O segment. At the end of June 2022, the power sector had a weight of 14.8 per cent (the highest weight in the momentum index), followed by 14.5 per cent of Oil & Gas and 12.2 per cent of capital goods. Currently, the momentum index is overweight on metal, consumer services, power and capital goods sectors compared with the Nifty 200 index. Given the momentum index is dynamic in nature, the sector weight saw marked changes over a period of time. For instance, in 2020 and 2021, the healthcare sector had a weight of 30-35 per cent in the index—during peak Covid, but as the economy entered the recovery mode, healthcare weight dropped to 5 per cent.

Over longer time frames, the Nifty 200 momentum 30 index has outperformed the benchmark Nifty 200 and Nifty 50 index by 200-300 basis points. Out of the last 10 years, the momentum total return index has outperformed for eight years. In the last ten years, the Nifty 200 momentum 30 total return index delivered a return of 19.8 per cent on a CAGR basis. The risk-adjusted return of the momentum index is 1.1 in the last decade, while the Nifty 50 was 0.8, which shows superior risk-adjusted for the momentum index.

By investing in momentum based ETF and Index Fund, investors can capitalise from the momentum strategy in a passive manner.