We have a portfolio that’s purely based on near-term Momentum in Capitalmind Wealth. This gives you the option to diversify your investments into a strategy that has worked over time, even if it adds a layer of short term risk.

Momentum investing differs from all the “finding opportunities at the market lows” that we speak about in our long term portfolio. It goes against the basic funda of buying low and selling high.

Momentum is all about buying high and selling higher. The idea that stocks that go up continue to go up. And just the concept of keeping your winners and getting rid of losers is enough to give you a good long term return.

The Momentum Strategy

In the stock market, Momentum is a word used to describe either price or earnings. When a stock is moving higher in price, it’s called to be in Momentum. And when companies come out with better earnings every quarter — they have earnings momentum.

Momentum has its roots in what is generally known as Trend Following — Cut the losers, let the Winners ride. It’s a style premia that is similar to Value Investing with the difference being that rather than betting on businesses, we are betting on the trend of the price to continue in the same orbit.

At Capitalmind Wealth, we shall be using what is better known as Time Series Momentum. Our strategy is totally systematic and ranks stocks on combination of two parameters — Risk and Return. The strategy loves to buy stocks that showcase strong trends with low volatility.

There’s literature that shows how momentum beats the market in the longer term. In fact, indexes are mostly based on momentum itself — the Nifty is the top 50 stocks in India, and the top 50 are chosen based on total market capitalization which is based on the stock’s price. Stocks that lose momentum in price are taken out of the index. In general, momentum has beaten the index over large periods of time, if used appropriately.

Presentation:

Momentum Investing

Diversification

We reduce individual stock risk through three mechanisms:

• Manual filters to remove stocks with low volumes (manipulation is rife here)
• Diversification across a large number of stocks (30)
• Going to cash when enough stocks aren’t available

While our Momentum strategy tries to side step questionable stocks using filters we have devised, the fact remains that the strategy can fail to identify stocks that fulfil all the criteria listed and yet fall like a pack of cards.

We have seen that in history with stocks like Vakrangee. By diversifying our portfolio across 30 stocks, we limit the damage any single stock can have on the overall portfolio. In times when we cannot find 30 stocks, we would rather sit in cash than deploy more than what is warranted for a single stock.

Risk Management:

Managing Risk is a key pillar of the system. We manage risks in two ways.

The first way is diversification. By diversifying across 30 stocks, we automatically reduce the impact of a stock pick or two going wrong.

The second way is through at the stock level. Both at point of selection and through the period it stays in the portfolio, we measure volatility constantly. Stocks that deviate broadly from historical trends are penalized which reduces their chance of remaining in the portfolio for long.

Risks

The Momentum Strategy is extremely risky because it bets on price momentum, which can reverse sharply and easily. Also, Small Caps are generally more volatile than Large Caps owing to low liquidity and sharper moves on either side. This strategy can experience quick downside losses in bear markets.

In the past, the system has selected stocks which have fallen 50% or more without giving a chance for exit. Since exchanges in India limit the daily stock price moves to a certain percentage, we may face a situation of unable to exit few portfolio stocks.

Invest only so much that you don’t have to worry about. Frequently checking performance never helps for compounding is not a straight line. We believe that it would require a minimum of 3 years before you can judge the performance against other alternative investment opportunities.

How much to Allocate

That is all wonderful you say, but given the risks, how much of one’s portfolio should one allocate to factors such as Momentum.

When we invest into Equities, we knowingly or unknowingly are exposed to all three key factors that more or less make up the factor universe — Quality, Value and Momentum.

True factor provides substantial opportunity for differentiated alpha generation.

Our Capitalmind Long Term PMS Portfolio offers a mix of Value and Growth. Now with Momentum, we are covering all the factors that influence stock returns. Depending on your comfort zone, you should allocate anywhere between 20% to 60% of equity capital to Momentum.

Adding Momentum as part of your Portfolio

The 1, 2, 3, 4 and 5 year average rolling return for Nifty 50 is 16.62%, 14.50%, 12.80%, 11.61% and 11.35% respectively. If you were to add a 20% allocation to Nifty Alpha 50, the average rolling return would go up to 18.74%, 15.93%, 13.94%, 12.56% and 12.15% respectively.

In other words, even a small allocation of Momentum to your portfolio can add Alpha over the long term.