Should You Invest in Alpha or Momentum Funds in India?

Momentum factor considers stocks that have performed well in the recent past and are likely to outperform in the near future. Obviously, there is no explanation as to why the speed factor works. But its ability to generate superior returns has earned it the title ‘Premier Anomaly’ (for market efficiency).

The alpha strategy considers stocks with higher alpha or higher returns than the benchmark. Thus, this strategy chooses stocks that generate high alpha over a specified period.

Both Alpha and Momentum indexes are made up of stocks that have performed well in the recent past. Anoop Vijayakumar, Fund Manager, CapitalMind, said, “Alpha and Momentum are based on similar principles but are implemented differently.

high downside risk

In India, popular indices based on alpha and momentum themes are Nifty 200 Momentum 30 Index and Nifty Alpha 50 Index. Motilal Oswal, Kotak and UTI Mutual Fund Passive funds have been launched on the basis of these indices in the last one year.

Nifty 200 Momentum 30 Index gives exposure to 30 high-movement stocks in the large and mid-cap stocks within the Nifty 200 index. Whereas the Nifty Alpha 50 Index is a very diversified index, consisting of 50 stocks in the large-, mid- and small-cap space with the highest alpha of the top 300 companies. The sharp jump in the mid- and small-cap space over the past two years is reflected in the returns generated by this index.

IT, consumer goods, financial services, metals, power and chemicals are the sectors that currently have high sector weights in these indices. Financial services, which is a major sector in the basic indices with a minimum 30% share, constitutes only 10–12% in the Momentum and Alpha indices.

These indices have outperformed other benchmark indices with significant differences across different time frames (see table). However, proving that high returns come with high risk, these indices saw a serious correction during market downturns (as shown in the second table). These indices also experience high volatility. Price volatility, as measured by the standard deviation of each of these indices, is up about 21% for the one year ended February 28. This is against the 16.3% recorded for their parent indices- Nifty 200 and Nifty 50.

Who can invest?

Investors who are comfortable with potentially high volatility on the downside may consider investing in these. Experts encourage investing in the momentum style because of its ability to control losses in comparison to the alpha index during market corrections.

“Alpha outperforms with a considerable margin in some years, but it loses a lot. Based on 15-year returns, Momentum has shown better performance and less downside volatility than Alpha,” said Vijayakumar of CapitalMind , which is why I think Momentum is a better factor than Alpha.

The higher downside risk of the Alpha Index could be due to the higher risk in the mid- and small-cap space as compared to momentum. Anish Teli, Managing Partner, QED Capital Advisors LLP, said, “Momentum is good in the way that it focuses on the top 200 companies that have good corporate governance and good liquidity.”

Every investment strategy comes with its own pros and cons. The Momentum Index of Nifty has outperformed other benchmark returns not only when the market is correct but also in recovery market cycles. According to experts, keeping the investment for a long period of time will help in getting good returns.

“If one has a time horizon of more than ten years and can tolerate some volatility, the momentum index can work very well,” Vijayakumar said.

Vishal Dhawan, Founder and Director, Plan Ahead Wealth Advisors said, “It is ideal that investors buy these funds through SIPs or STPs to better manage volatility when the markets are down.”

Experts also suggest combining this strategy with other less volatile strategies. “The combination of momentum and general indices works well for investors who are aggressive,” said Dhawan. Thus, if you have already invested in a broad-based index, you may consider momentum investing to some extent to boost returns.

“For conservative investors, who find momentum very uncomfortable, they can combine momentum with a fund with lower volatility, to offset the downside slightly,” Dhavan concluded.

One should be wary of investing in multi-factor index funds like Alpha Low-Volatility Index.

“When you combine the factors, you can end up in a position where you can pick stocks that are not the best in either factor. Half the weighting can be done for each factor and you end up with one such stock. The ends that are not the most alpha or the least volatile,” Vijayakumar said.