What are Momentum Funds?

Introduction

Momentum funds are a category of equity mutual funds or exchange-traded funds (ETFs) that follow the investment philosophy of buying stocks that have demonstrated strong price performance and positive market trends.

The core idea is based on the principle that “winners tend to keep winning” over a period of time.

Unlike traditional value investing, where investors look for undervalued companies, momentum investing focuses on identifying companies that are already showing strong investor interest, improving business performance, or positive market sentiment.

The concept is rooted in behavioural finance. Investors often underreact to new information, causing stock prices to continue moving in the same direction for some time. Momentum funds attempt to capture this trend by systematically investing in stocks with strong recent performance.

How Do Momentum Funds Work?

Momentum funds typically select stocks based on quantitative factors such as:

• Price momentum: Stocks that have delivered higher returns compared to their peers over a specific period, usually 6–12 months.
• Relative strength: Companies showing stronger price trends compared to the broader market.
• Liquidity and quality filters: Many funds combine momentum with parameters like market capitalisation, earnings growth, or volatility control.

For example, if a banking stock has consistently outperformed the Nifty 50 index due to strong earnings growth and positive investor sentiment, a momentum fund may increase its allocation to that stock.

However, momentum investing requires regular portfolio rebalancing because trends can reverse quickly. A stock that was a market favourite six months ago may lose momentum due to changing fundamentals or investor sentiment.

Momentum Funds in the Indian Context

Momentum investing has gained popularity in India with the growth of factor-based investing and passive funds. Indian investors traditionally preferred large-cap, value, and growth funds, but momentum strategies have emerged as an alternative approach.

The Indian stock market has experienced several strong momentum cycles, particularly in sectors such as information technology, banking, defence, infrastructure, and manufacturing.

Some examples of momentum-oriented funds in India include:

1) Nippon India ETF Nifty 200 Momentum 30 ETF

This ETF tracks the Nifty 200 Momentum 30 Index, which selects 30 companies from the Nifty 200 universe based on momentum scores. The index periodically rebalances to include stocks showing stronger price trends.

2) UTI Nifty200 Momentum 30 Index Fund

This is an index fund based on the same momentum factor strategy. It provides investors exposure to companies demonstrating strong relative performance within the large and mid-cap universe.

3) ICICI Prudential Nifty 200 Momentum 30 ETF

Another passive product focused on capturing momentum trends across India’s top 200 companies.

Advantages and Risks of Momentum Funds

Momentum funds can outperform broader markets during strong bull phases because they concentrate on stocks already experiencing positive trends. They also remove emotional decision-making by following a rules-based approach.

However, momentum strategies come with risks. They can experience sharp declines when market trends reverse. Since these funds often buy stocks after they have already performed well, valuations may become expensive. Frequent portfolio changes can also increase transaction costs.

Therefore, momentum funds may work best as a satellite allocation within a diversified portfolio rather than as a replacement for core equity investments.

Conclusion

Momentum funds represent a shift from traditional investing approaches by focusing on market behaviour and price trends. In India, increasing awareness of factor investing has made momentum strategies accessible to retail investors through ETFs and index funds.

For investors who understand market cycles and can tolerate higher volatility, momentum funds can provide an additional strategy to participate in emerging market trends. However, like any investment approach, they require discipline, diversification, and a long-term perspective.

References

1. Jegadeesh, Narasimhan & Titman, Sheridan (1993). Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.
2. Mark R. Carhart (1997). On Persistence in Mutual Fund Performance.
3. A Random Walk Down Wall Street – Burton G. Malkiel.
4. NSE Indices – Nifty200 Momentum 30 Index methodology.
5. Morningstar India – Research articles on factor investing and momentum strategies.