Momentum Strategies in Indian Markets: Insights from a 10-Year Backtest Analysis

Introduction:

Momentum investing, a strategy that capitalizes on the continuance of existing market trends, has long fascinated investors and academics alike. In the context of the dynamic Indian market, understanding the efficacy of momentum strategies can be crucial for investors seeking to optimize their portfolios. This article presents an in-depth analysis of various momentum strategies, backtested over 5 and 10-year periods using the Nifty 200 Universe.

Our study aims to shed light on the performance, risks, and practical implications of implementing momentum strategies in the Indian equity market. By examining different lookback periods and rebalancing frequencies, we seek to uncover insights that can inform investment decisions and strategy development.

Methodology:

To ensure a comprehensive and robust analysis, our study incorporated the following key elements:

1. Data Universe: We focused on the Nifty 200 Universe, providing a broad representation of the Indian market that includes both large and mid-cap stocks.
2. Timeframe: Backtests were conducted over both 5 and 10-year periods, allowing us to assess short-term performance and long-term sustainability of the strategies.
3. Strategy Variations: We tested four distinct momentum strategies, each with two rebalancing variations (2 weeks and 4 weeks).
4. Survivorship Bias Elimination: To maintain the integrity of our results, we carefully eliminated survivorship bias, ensuring our analysis accurately reflects real-world conditions.
5. Performance Metrics: We evaluated strategies based on CAGR (Compound Annual Growth Rate), Standard Deviation, Sharpe Ratio, and Maximum Drawdown, providing a multi-faceted view of performance and risk.

Strategies Tested:

Our analysis focused on Rate of Change (ROC) and Risk-Adjusted Returns (RAR) strategies:

1. ROC 1,3,6 months (rebalanced every 2 weeks and 4 weeks)
2. ROC 3,6,9 months (rebalanced every 2 weeks and 4 weeks)
3. ROC 6,12 months (rebalanced every 2 weeks and 4 weeks)
4. RAR 6,12 months (rebalanced every 2 weeks and 4 weeks)

These variations allowed us to examine the impact of different lookback periods and rebalancing frequencies on strategy performance.

Results Analysis:

Backtest results of Momentum Strategies

5-Year Performance:

Over the 5-year horizon, our analysis revealed several notable findings:

1. Top Performer: The ROC 1,3,6–2Wk strategy emerged as the clear leader, delivering an impressive 40% CAGR. This strategy also boasted the highest Sharpe Ratio at 160%, indicating superior risk-adjusted returns.
2. Consistency Across Timeframes: Interestingly, strategies using the 1,3,6 month lookback period consistently outperformed others, regardless of rebalancing frequency. The 2-week rebalancing variant slightly edged out its 4-week counterpart (40% vs. 37.68% CAGR).
3. Trade-off with Transaction Frequency: While the top-performing strategy showed impressive returns, it also required the highest number of transactions (881), potentially increasing implementation costs and complexity.
4. Risk Considerations: Despite its lower CAGR (35.62%), the RAR 6,12–2Wk strategy demonstrated the lowest standard deviation (23.66%), suggesting it might be suitable for more risk-averse investors.

10-Year Performance:

Extending our analysis to a 10-year period provided insights into the long-term sustainability of these strategies:

1. Sustained Performance: The ROC 6,12–2Wk strategy emerged as the top performer over this extended period, with a CAGR of 23.02% and a Sharpe Ratio of 101%.
2. Reduced Transaction Frequency: Longer lookback periods generally required fewer transactions, with the ROC 6,12–4Wk strategy needing only 1053 trades over 10 years.
3. Drawdown Considerations: All strategies experienced significant maximum drawdowns, ranging from -29.99% to -34.66%. This highlights the importance of risk management in momentum investing.
4. Rolling Returns: The 3-year rolling returns provide a nuanced view of performance consistency. The ROC 3,6,9–2Wk strategy showed the highest rolling returns at 20.70%, suggesting it might offer more stable performance over time.

Key Insights and Implications:

1. Short-term vs. Long-term Performance: Our results indicate that strategies with shorter lookback periods (3–9 months) tend to outperform in up-trending markets. However, over extended periods, strategies using longer lookback periods (6–12 months) generally provided better returns.
2. Rebalancing Frequency Impact: More frequent rebalancing (2 weeks vs. 4 weeks) tended to yield slightly better results, but at the cost of increased transaction frequency. Investors must weigh this trade-off based on their investment size and tolerance for active management.
3. Risk-Adjusted Performance: While some strategies showed higher absolute returns, others demonstrated better risk-adjusted performance. The choice between these depends on an investor’s risk tolerance and investment goals.
4. Implementation Challenges: The high turnover in some strategies, particularly those with shorter lookback periods, presents practical challenges in terms of transaction costs and tax implications. These factors must be carefully considered in real-world applications.
5. Market Cap Considerations: Our analysis suggests that DIY momentum strategies applied to the Nifty 200 might be losing their edge compared to the Nifty200 Momentum 30 and Nifty Midcap 150 Momentum 50 indices. This could indicate increasing market efficiency or a shift in momentum effects across different market capitalizations.

Conclusion:

Our comprehensive backtest of momentum strategies in the Indian market reveals both the potential and the challenges of this investment approach.

While certain strategies demonstrated impressive returns, they also came with increased complexity and potential for significant drawdowns.The evolving nature of market efficiency suggests that strategies that have worked well in the past may not continue to do so in the future.

Future research could explore the impact of transaction costs, examine sector-specific momentum effects, or investigate the combination of momentum with other factors like value or quality. Such studies could further enhance our understanding of how to effectively harness momentum in the dynamic Indian market environment.

Remember, while backtests provide valuable insights, they are not predictive of future performance. Always conduct thorough due diligence and consider seeking professional advice before implementing any investment strategy.

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Important Links
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