Introduction

Momentum funds are becoming increasingly popular among Indian investors looking to invest in high-growth options on the Indian stock market. These investment vehicles aim to capture market momentum by operating in a targeted manner. They can provide great returns to investors, but they do present some risk. This article explains what momentum funds are, how they work, and whether they would be suitable for investors in India. It serves as a useful road map for assessing this high-velocity investment topic.

Understanding Momentum Funds

Momentum funds are either capitalised as mutual funds or exchange-traded funds (ETFS) that invest in stocks or securities that have risen steadily over a specified period (usually between 3-12 months). The concept is straightforward: assets that have performed well recently will likely continue to rise in the short term, and those that have not performed well will likely stay weak. The investor relies on detecting a "trend" (to ride a wave) and riding that wave until it is time for the investor to get out.

Due to India's active equity markets, momentum funds are popular, particularly in sectors exhibiting intrinsic trends such as technology, pharmaceuticals, and banking. These strategies appeal to investors who are comfortable with risk and considering short- and medium-term returns.

How Momentum Funds Work

Momentum funds typically follow a set of steps to develop the portfolio:

1. Identifying the Top Performers: Fund managers use quantitative metrics to track stocks that have gained value over periods, measured in months (usually 6 or 12 months). These measures include price momentum and relative strength (how a stock performs compared to other stocks). For example, if Reliance Industries or Infosys have had momentum in 6-12 months, they can put that stock on the watch list.

2. Rebalancing the Portfolio: Momentum funds regularly rebalance their portfolios to encourage stocks to continue their upward trend, regularly (weekly, monthly, at least quarterly). To do this, the fund manager needs to sell stocks with lost momentum and add stocks with upward price momentum. While the portfolio is dynamic, and the fund manager can attempt to stay low-cost, some cost is still associated with high turnover.

3. Active or Passive Management: Some momentum funds are truly active, with active fund managers attempting to make more informed decisions based on their general insight into the market and trends. Other momentum funds are passive and base their decisions on rules (e.g., an ETF tracks a Nifty High Beta 50, High Beta, or Momentum Index).

4. Trend-Focused Strategy: Momentum funds are different from value investing, which is concerned with greater value that is undervalued. Instead, momentum funds are primarily concerned with where stocks are trending. They don't care if the trend will reverse, but want to take advantage of the stock's momentum.

 Types of Momentum Fund:

There are many different forms of momentum funds to satisfy a wide range of investors.

• Sector Funds- These focus on high-momentum stocks in niche sectors like IT, healthcare, etc. For instance, one could invest in or start a momentum fund in India's growing tech sector with IT companies like TCS or Wipro.

• Broad Market Funds- These funds invest in high-momentum stocks across sectors to reduce sector-specific risk with diversification.

• Index Funds- These are low-cost investments that replicate momentum index-based strategies.

• Active Funds- These funds are actively managed by professionals who apply expected momentum strategies and market analysis to achieve higher returns.

Benefits of Momentum Funds

Momentum funds offer advantages for investors:

• High Return Potential: In bullish markets, like India’s post-COVID recovery, momentum funds can deliver substantial gains by riding sector upswings.

• Data-Driven Approach: The reliance on measurable metrics minimises emotional decision-making, appealing to disciplined investors.

• Diversification: Broad market funds spread investments across industries, mitigating risks tied to a single sector.

Risks to Consider

Despite their appeal, momentum funds carry significant risks:

• Volatility: Momentum stocks can be very volatile, especially during market corrections. Markets can reverse quickly, leading to swift losses.

• High Costs: Short-term trading means higher expense ratios and transaction costs, which will eat into returns.

• Tax Issues: In India, when an investment in equity funds is held for less than one year (as of April 2025, including cess), short-term capital gains (STCG) are taxed at 20%. A higher turnover rate can often lead to STCG, reducing net returns.

• Market Conditions: Momentum funds perform best in trending markets but have difficulty in choppy/bearish market conditions where momentum has lower beta.

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Who Should Invest?

Momentum funds are best suited for investors with a high day-to-day volatility risk appetite and a horizon of over 3 to 5 years. They are meant for investors on the upper end of risk tolerance who are comfortable making investments based on the stock market's day-to-day price changes. Value investors, and those who have a lower-level risk appetite or are simply more interested in not losing capital over the long term, will likely want to stick with value funds or balanced funds in their portfolios.

To invest in momentum funds, consider these steps:

1. Do Your Research: Search for funds that deliver consistent performance and reasonable expense ratios. Some good examples are mutual funds based on the Nifty Momentum Index and actively managed alternatives from Asset Management Companies (AMCS) such as Nippon India or ICICI Prudential.

2. Assess your Risk Tolerance: Ensure your financial objectives are consistent with the fund’s high-risk profile.

3. Use Trustworthy Platforms: Invest through platforms or mutual fund apps with clear transparency of fees involved.

4. Monitor the Market Conditions: Momentum funds compete best with trending markets, so stay in touch with market conditions in economic indicators like GDP growth or the Reserve Bank of India's (RBI) executed policies.

Conclusion

Momentum funds present an exciting opportunity for investors to ride market trends, taking advantage of the vibrancy of a young equity market. Momentum funds primarily invest in assets with strong recent performance in anticipation of future high returns. Despite volatility and cost factors, momentum funds can be a valuable and powerful investment tool for a diversified long-term strategy for risk-tolerant investors, considering personal financial objectives and market factors. Always consult a financial advisor to ensure momentum funds suit your investment goals.

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