The appeal of momentum investing, with its “buy high, sell higher” mantra, has surged, challenging traditional investment norms. Yet, behind the simple idea lies a complex mechanism where fund size and trading volume can greatly influence success. In this space, careful calibration is essential, as larger funds risk distorting prices, while niche portfolios can better preserve strategy integrity.
The volume-momentum nexus
In the niche world of momentum investing, volume plays a pivotal role in determining a strategy’s effectiveness.
Large asset managers, often holding substantial cash to capitalize on market corrections, face limitations with their sizeable funds. These constraints make it challenging to invest in smaller, less liquid securities where momentum thrives, potentially missing key opportunities.
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Specialized momentum strategies, especially niche PMS portfolios, approach this differently, minimizing market impact and maintaining the purity of momentum signals. Designed to hold full market exposure, these portfolios only shift to cash when market-wide momentum significantly weakens—such as during the Covid-19 crisis—highlighting their resilience in varying conditions.
Fund size further impacts momentum by influencing market dynamics. Large funds entering or exiting illiquid positions can distort prices, creating artificial movements that obscure genuine momentum signals. This problem is heightened in passive momentum funds, which operate within a limited stock universe and follow predictable rebalancing schedules, making them vulnerable to front-running.
Evolution of active momentum strategies
Active momentum strategies have evolved to overcome traditional limitations. By expanding the investment universe to 750 or more stocks and adopting monthly rebalancing, these strategies provide distinct advantages. A broader universe allows for more high-momentum opportunities and better diversification, while monthly rebalancing—unlike the semi-annual adjustments of passive funds—enables quicker responses to emerging trends.
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The strength of this approach is underscored by recent performance: Valtrust’s Momentum PMS achieved returns of 59.1% in 2023 and 42.3% year-to-date in 2024, outpacing the S&P BSE 500 TRI’s 27.4% and 25.6%, respectively. Notably, this strategy captures higher gains during bullish phases while maintaining comparable performance in flat or bearish markets.
Portfolio construction: An art
Crafting a momentum portfolio requires a careful balance. A concentrated selection of about 30 stocks, algorithmically ranked by momentum scores, provides optimal diversification without diluting the strategy. This approach diverges from passive funds that often hold more stocks, which can weaken the momentum effect.
The stock selection process is rigorous, filtering the top 750 stocks by market cap through liquidity and governance criteria before applying momentum rankings. This purely bottom-up method focuses on price momentum, steering clear of subjective sector calls or market timing. Currently, this approach has led to concentrated positions in sectors with strong momentum, such as capital goods and financial services.
The road ahead
Success in momentum investing increasingly depends on striking the right balance between fund size and strategy effectiveness. Consistent performance requires preserving strategy purity through careful sizing, regular rebalancing, and a broad stock universe. As more investors turn to momentum opportunities, understanding these subtleties has become essential.
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The rise of momentum-focused PMS offerings marks a significant shift in the space, providing investors with the dual advantage of professional management and the agility to capture market trends. These offerings blend institutional-grade analysis with the flexibility to act on emerging opportunities, presenting a compelling alternative to traditional passive momentum strategies.
The authors are Arihant Bardia, CIO and founder of Valtrust, and Prashant Krishna, chief tehnical analyst at Valtrust.
