How to select the best Momentum Mutual Fund?
Investors seeking to capitalize on the momentum strategy often look towards Momentum Mutual Funds. This strategy involves investing in stocks that have shown an upward price trend. Within the realm of Momentum Mutual Funds, investors have a choice between active and passive funds. In this article, we will focus different categories of Mutual Funds and a detailed methodology on how to choose the best Momentum Mutual Fund.
To circumvent the tedious process of understanding all mutual funds and then analysing, we have developed a 3 step process.
- Analysing active v/s passive mutual funds
- Eleminating the weak becnhmarks based on returns
- Choosing the best mutual fund
Understanding Momentum Mutual Funds
There are two categories of Mutual Funds, Active and Passive Mutual Funds
Active mutual funds are managed by professional portfolio managers who actively make decisions about how to allocate assets in the fund. The goal is to outperform a specific benchmark index, such as the NIFTY 50, SENSEX 30 etc.. Fund managers use various strategies, including market research, economic forecasts, and analytical tools, to select stocks, bonds, or other securities they believe will provide the best returns.
Passive mutual funds, such as index funds, aim to replicate the performance of a specific index by holding a portfolio that mirrors the index’s composition. These funds are not actively managed, meaning the portfolio remains relatively static unless the index itself changes.
Since active mutual funds aim to beat the benchmark returns, we have attempted to understand if this objective is actually met.
According to the SPIVA (S&P Indices Versus Active) India report, a significant proportion (60–80%) of active mutual funds underperform their benchmarks over the long term. For instance, over a five-year period, a majority of active equity funds in India failed to beat their respective benchmarks.
Read complete report here: https://www.spglobal.com/spdji/en/spiva/article/spiva-india/
Given this information, we find it better to invest in passive mutual funds which aim to replicate returns of various benchmarks. There is another advantage to choosing passive mutual funds and that is their lower expense ratios. Since they are designed to replicate the performance of a specific index, which means they require less active management.
Moreover, passive funds offer greater transparency and predictability. Since these funds simply aim to match the performance of an index, investors have a clearer understanding of the fund’s holdings and strategy. This contrasts with active funds, where the performance can be highly dependent on the manager’s investment decisions, which can be less predictable and more volatile.
Now that we have established that passive mutual funds are the better option, let us see what are the offerings in momentum based passive mutual funds.
Analysis of benchmarks
Before we look into individual funds, let us see what are the different benchmark indices that are being developed and tracked by NSE.
· NIFTY 200 Momentum 30
· NIFTY MidCap 150 Momentum 50
· SmallCap 250 Momentum Quality 100
· NIFTY 500 Momentum 50 Index
· NIFTY MidSmallCap 400 Momentum Quality 100
To know more about individual index read here: https://www.niftyindices.com/indices/equity/strategy-indices/nifty-midsmallcap400-momentum-quality100
To more about the methodology used for creating these indices read here: https://www.niftyindices.com/Methodology/Method_NIFTY_Equity_Indices.pdf
Since we want to select the best performing passive momentum mutual fund, and since mutual funds replicate indices, we need to understand how the benchmarks are performing and which category is providing the best returns.
To calculate the returns and establish the ranking, we have used annualized returns of the index, standard deviations and sharpe ratio. All these data points are available in the factsheets of each index which can be found here: https://www.niftyindices.com/indices/equity/strategy-indices/nifty-midsmallcap400-momentum-quality100
Results of this analysis indicates that NIFTY MidCap 150 Momentum 50
In NIFTY MidCap 150 Momentum 50 there are two fund offering by TATA and Edelweiss. However in the third and final step we need to figure out which of these funds has be to chosen.
Choosing the best momentum mutual fund
But what difference is there between two passive mutual funds base on the same momentum index? The answer is twofold, one is expense ratio and two tracking difference error.
· Expense Ratio is the annual fee that investors pay for fund management. A lower expense ratio directly translates to higher net returns for investors.
· Tracking Difference Error, this measures how closely the fund’s performance matches that of its underlying index. A lower tracking error indicates better management efficiency in mirroring the index.
We must remember that tracking difference occurs due to two reasons, one is the transaction costs which are not considered in when the index returns are calculated. And the second reason is the dynamic change in price of stocks and the time difference between funds in buying and selling of these while rebalancing.
So now to finally select the best mutual fund we compare the above two metrics (expense ratio and tracking error) between TATA and Edelweiss
Fund House: TATA
Expense ratio: 0.31%
Tracking Difference Error (1 year): 2.85%
Fund House: Edelweiss
Expense ratio: 0.30%
Tracking Difference Error (1 year): 3.55%
To conclude, the TATA NIFTY Midcap150 Momentum 50 fund is the best Mutual Fund with least expense ratio and tracking difference error.
Here is a list of passive momentum based mutual funds and their key statistics for you to check out.
View this video in English:
https://youtu.be/3d9B1f1FB8s
View the video in Telugu (May 2024):
https://www.youtube.com/watchv=MfMMquf3unQ&list=PLZw2nkqj71whDYfoc1U9NkFXxO3R7Ltfw
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QuantX-Builder for Mastering Momentum Investing. 4 week comprehensive learning programme.
bit.ly/QuantX-MomentumLAB
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Important Links
Youtube: https://www.youtube.com/@MomentumLab_IN
Twitter: https://x.com/MomentumLab_IN
**Disclaimer:** We are not SEBI registered advisors. Any content shared on or through our digital media channels is for information and education purposes only and should not be treated as investment or trading advice. Please do your own analysis or take independent professional financial advice before making any investments based on your own personal circumstances. Investment in securities is subject to market risks; please carry out your due diligence before investing. And last but not least, past performance is not indicative of future returns.
