Should you invest in the Nifty 500 Momentum 50 Index?

There are currently two ongoing NFOs – Motilal Oswal Nifty 500 Momentum 50 Index Fund (and ETF) and Nippon India Nifty 500 Momentum 50 Index Fund. In this article, we analyse the risk and reward potential of the underlying index and what you need to know before considering a momentum index.According to the index factsheet, The Nifty500 Momentum 50 Index aims to track the performance of the top 50 companies within the Nifty 500 selected based on theirNormalized Momentum Score. The Normalized Momentum Score for each company is determined based on its 6-month and 12-month price return, adjusted for volatility. Stock weights are based on a combination of the stock’s Normalized Momentum Score and its free-float market capitalization.To compute the Normalized Momentum Score:12-month Momentum ratio = 12-month Price Return ÷ standard deviation (SD) and 6-month Momentum ratio = 6-month Price Return ÷ SD are computed.Annualised standard deviation of lognormal daily returns of the stock for one year is used.Z-Score for 12-month & 6-month momentum ratio is calculated. Z-score is the deviation from the mean momentum ratio divided by the standard deviation of momentum ratios.Weighted Average Z Score = 50% * (12 month Momentum Z Score) + 50%* (6 month Momentum Z Score)Normalized Momentum Score = (1+ Wgt. Average Z score) if Wgt. Average Z score>=0Normalized Momentum Score = (1- Weighted Average Z score)^-1 if Wgt. Average Zscore < 0The top 50 stocks with the highest Normalized Momentum Score are selectedEach stock in the index is capped at the lower of 5% or five times the weight of the stock in the index based only on free-float market capitalizationCapping will be done semi-annually at the time of rebalancingThe weight of stocks may drift between two rebalancing periods due to movement in the stock pricesConsiderations for investorsIs this definition arbitrary? Why choose only 6-month and 12-month windows? Why not 3-month or 9-month windows?Why wait 6-months for a rebalance? Will there not be momentum shifts within that time? Recall the 2020 crash and recovery lasted only a month.Even a casual inspection of the index methodology would tell us that the Nifty 500 Momentum 50 Index is expected to do well in a bull market. But what about bear markets when there is a lack of momentum?Now, let’s look at the data. The rosy parts first. If you want to create plots like the ones below, you can join the freefincal investor circle to access exclusive tools.Evolution of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI since 1st April 2005 in log scaleEvolution of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI since 1st April 2005 in log scaleAll since-inception graphs would look exciting like this. But we need to dig deeper (see below).10-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty Smallcap 250 TRI vs Nifty Midcap150 TRI vs Nifty Multicap 50-25-25 TRI10-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty Smallcap 250 TRI vs Nifty Midcap150 TRI vs Nifty Multicap 50-25-25 TRIThat seems impressive. Before we get carried away, we need to look at the time window in the X-axis. It is less than ten years old. So, the history is way too short to have seen a variety of possibilities.10-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty Next 50 TRI vs Nifty 50 TRI10-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty Next 50 TRI vs Nifty 50 TRISame caveat as above.10-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI vs Nifty 50 TRI10-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI vs Nifty 50 TRISame caveat as above. This graph also illustrates why I keep saying you don’t get much “extra” by choosing Nifty 500 over Nifty 50.Now, let us get to the nitty-gritty.10-year rolling risk (standard deviation) of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI vs Nifty Smallcap 250 TRI vs Nifty Midcap150 TRI vs Nifty Next 50 TRI10-year rolling risk (standard deviation) of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI vs Nifty Smallcap 250 TRI vs Nifty Midcap150 TRI vs Nifty Next 50 TRINotice that the Nifty 500 Momentum 50 has one of the largest standard deviations (volatility) among the indices compared to the small cap index, even higher than the small cap index. This is the price to pay for the higher return “over the long term”.Show investors a ten-year rolling return graph like this, and they would claim they will stay invested for that long to reap benefits (if any). But talk is cheap. Investors must appreciate that the journey to such a potential higher return is riddled with risk.5-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI vs Nifty 50 TRI5-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI vs Nifty 50 TRINotice that five-year returns of the momentum index fall down to Nifty 50 levels from time to time, and when there is no market momentum, outperformance becomes hard. New mutual fund investors may find it hard to believe market momentum may vanish for long, but it is only a matter of time before it happens.3-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI vs Nifty 50 TRI3-year rolling returns of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI vs Nifty 50 TRIThe risk is more apparent when we consider three-year rolling returns. So, if you wish to hold the momentum fund for ten or more years, you must be prepared for years of underperformance. Most investors are incapable of this.Motilal Oswal AMC’s presentation deck compares the momentum index’s drawdown with that of Nifty 50.Drawdown of Nifty 500 Momentum 50 TRI vs Nifty 50 TRI from the presentation deck of Motilal Oswal AMCIt is clear that the momentum index falls more from a peak and tends to stay down longer. More instances of its volatile nature can be seen below.Evolution of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI from April 2005 to July 2009Evolution of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI from April 2005 to July 2009What goes up fast also comes down fast. Now, is that a smart way of investing?Evolution of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI from July 2009 to July 2023Evolution of Nifty 500 Momentum 50 TRI vs Nifty 500 TRI from July 2009 to July 2023One of the reasons for its extreme volatility could be that the 50 chosen stocks from the Nifty 500 may have a good chunk of small cap or mid cap stocks. When the trend reverses, they fall as hard as they move up.Should you invest in the Nifty 500 Momentum 50 Index?It is too volatile (than a small cap index) to be the mainstay of a portfolio. At best, it can only be a sidekick included to satisfy the FOMO itch. But then again, mature investors would recognise that sidekicks only increase clutter and do not significantly impact wealth.Our recommendation is to avoid momentum-based passive funds. If you “must” include it, add a small exposure. But then again, you can’t keep doing that each time there is a fancy NFO every few months.Also see:Do share this article with your friends using the buttons below. 🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users! Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this! New Tool! => Track your mutual funds and stock investments with this Google Sheet! 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