What are Momentum Funds?

Momentum funds focus on assets/stocks demonstrating strong upward price trends, based on the idea that stocks that have done well in recent times are expected to continue doing well in the future. These mutual funds look to identify stocks/securities that have done well in recent times as compared to the broader market or those showing steady price growth over a certain duration.

Quantitative analysis is leveraged for identification and investments in these funds based on parameters like earlier price movements, trading volume, relative strength, etc. Let us learn more about them below. 

Features of Momentum Funds

Now that you know what a momentum fund is, here are some of its major attributes. 

• These funds aim at capitalizing on upward market trends by deploying investments in those stocks that have demonstrated robust price performance. 
• They have potential for higher returns although there are always risks of enhanced volatility and losses in case of market corrections. 
• Riding the momentum/trend is the key attribute, with a short-term focus on price trends and movements in place of long-term analysis. 
• Dynamic weighting is another attribute of momentum funds where some funds tweak their portfolio allocation dynamically, depending on evolving conditions in the market. The goal here is to capture new investment opportunities with market changes. 
• Some funds may target diversification of the portfolio while others may concentrate on particular stocks/sectors. 
• Most of these funds are managed actively by fund managers who make decisions on the stocks to sell/buy, depending on their own analysis of market movements. Some of them are tailored to track only a particular momentum index, ensuring a more passive investment approach. 

Advantages of Investing in Momentum Funds

Once you have a better idea of the momentum fund meaning, knowing about its major advantages is also essential. 

Potential for Higher Returns in Bull Markets

Momentum funds tend to do well in strong bull markets since they invest in stocks that are already showing an upward trend. 

Higher Return Probability

You can make a profit by leveraging recent price trends or identifying stocks with immense short to medium-growth potential. Thus, taking advantage of short to medium trends is possible with a higher probability of returns.

Eliminating Emotional Biases

A key advantage is that active trading can help leverage market inefficiencies and create newer profit-making opportunities, while the overall approach is objective and quantifiable (based on metrics and price trends), which eliminates emotional biases in selecting stocks.

Diversifying the Portfolio

Portfolio diversification without relying solely on market capitalization or other value factors is another advantage along with flexibility in crafting momentum strategies and responding to market conditions dynamically.

Risks and Considerations

Here are some of the risks and potential watch-outs while investing in momentum funds. 

High Volatility Risks

Investors have to contend with higher volatility due to frequent fluctuations in the market and risks of losses during corrections. This is because these funds depend mostly on short-term trends. 

Not Suitable for Sideways or Bearish Markets

Fund performance may also suffer in range-bound or sideways markets since stock prices move in a narrower band without any clear indication of downward/upward momentum. They have also historically underperformed in bear markets, often witnessing major drawdowns during downturns. 

Higher Churn Rates, Expense Ratios & Transaction Costs

Churn rates are higher since fund managers dynamically tweak the asset mix to capture momentum in the short to medium term. Frequent selling and buying of assets may also lead to higher transaction costs and expense ratios. 

Requires Accurate Timing & Extensive Research

Investing in these funds involves extensive market research and monitoring of individual stock performance, while accurate market timing is another consideration. 

Who Should Invest in Momentum Funds?

Investors with higher risk tolerance can consider investing in momentum funds. Also, those looking to tap short to medium-term growth opportunities in the market can also consider the same. It’s always recommended that you have ample knowledge and understanding of market trends and cycles while looking to diversify your portfolio more aggressively. 

You should be comfortable with potential short-term losses and fluctuations while being willing to invest time into actively managing investments and understanding the characteristics of various funds. 

Tax Implications of Investing in Momentum Funds

Here are some key aspects worth noting about the tax implications of these funds -

• Depending on the period the momentum funds are held, short-term capital gains (STCG) or long-term capital gains (LTCG) may be applicable
• If the funds are held less than a year, gains will be taxed on STCG at 20%. Furthermore, the gains will be considered LTCG if the funds are held for one year or more. The applicable tax on LTCG in this case would be 12.5% if the gains exceed ₹1.25 lakh per year. 
• Dividends derived from these funds are subject to DDT (dividend distribution tax) and are deducted before being distributed to investors. Dividends exceeding ₹5,000 are subject to 10% Tax Deducted at Source (TDS). 
• Remember, frequent buying and selling not only increases the expense ratio but also comes with tax implications. 

Conclusion

Momentum funds are worth considering if you have a higher appetite for risk and are willing to aggressively diversify your portfolio. However, there are risks of losses and volatility, particularly during market downturns or corrections that you need to consider before investing. If managed well, these funds can be value-additions to any portfolio. Get professional guidance from the experts and start your mutual fund investment journey today. 

Disclaimer: This content is solely for educational purposes. The securities/investments quoted here are not recommendatory.

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