Momentum investing - an emerging strategy for growth seekers

Momentum investing is a compelling strategy that has garnered attention for its distinctive approach - identifying and capitalising on assets that demonstrate strong, upward trends. Unlike traditional investing models that seek undervalued stocks or companies with high intrinsic growth potential, momentum investing centers on the principle of “buying high to sell higher.” As this strategy becomes more accessible in India, particularly through new funds and indices, investors seeking dynamic returns may find it a valuable addition to their portfolios.

The appeal

At the heart of momentum investing is a powerful insight into market behavior: recent market winners are likely to continue performing well in the short term due to collective investor sentiment. For growth-oriented investors, this strategy offers a way to actively capture short-to-medium-term gains by riding these trends. When contrasted with approaches like value investing, which seeks underpriced assets, momentum investing aligns with investors willing to capitalise on performance trends without the expectation of holding assets for long periods.

The mechanics

The strategy is grounded in robust quantitative methods and behavioral finance principles. Investors rely on indicators such as price momentum and relative strength to gauge the performance and trajectory of assets. This approach not only takes advantage of market sentiment but is also flexible—adapting across different asset classes, sectors, and market conditions. For instance, a fund applying a momentum strategy may reallocate between large-cap and mid-cap assets based on prevailing trends, ensuring it remains responsive to shifting market dynamics.

Key drivers

Momentum investing in India benefits from a few unique drivers. First, the Indian market’s historical performance shows that momentum indices, such as the Nifty200 Momentum 30, have often outperformed broader benchmarks on a risk-adjusted basis. This is partly due to the adaptability of momentum strategies—they recalibrate with changing market cycles, making them suited to India’s varied economic conditions. 

Risks & rewards

While momentum investing has demonstrated a strong performance profile, particularly in terms of risk-adjusted returns, investors must understand its inherent volatility. Momentum portfolios can be more sensitive to shifts in market sentiment, and in downturns, this sensitivity can translate to greater risk. However, data from recent years suggests that momentum-based strategies have shown resilience by outperforming traditional indices in certain challenging market phases. The key for investors is to leverage these funds as part of a diversified portfolio, balancing momentum’s potential for above-average returns with its periodic volatility.

Ultimately, momentum investing offers investors a unique and adaptable strategy, focusing on performance trends that respond to market shifts. While not a replacement for traditional strategies, it can complement a balanced portfolio by offering exposure to market trends that capture current economic drivers. Investors should, however, approach momentum with a clear understanding of its mechanics and work with financial advisors to gauge its fit within their broader financial goals. With a thoughtful application, momentum investing can be an effective way to capitalise on the market’s prevailing winners, with an aim to turning today’s trends into tomorrow’s potential returns.

(The author is Fund Manager, Axis Mutual Fund)