Index investing is a passive investment technique that attempts to generate returns similar to a underlying benchmark index. An Index investment vehicle, tracks a market index or a specific market segment, to construct a portfolio of underlying index.
What is an Index Fund?
Index fundis a type of mutual fund scheme which is managedby tracking/replicating underlying benchmark index. As against actively managed funds where fund manager decides where to invest and how much to invest and when to invest, index funds are passively managed by mimicking a particular index i.e. fund manager endeavor to keep the composition and weight of stocks as it is in the underlying index. These funds endeavor to offer returns that are generated by underlying index subject to cost and tracking error
Types of Index funds:
Index funds are of multiple types, depending upon the underlying benchmark index that they replicate/track. Index Funds may track indices which can be on broad market generally known as cap-weighted index. These type of index funds are popular and widely used and are also known as beta trackers. Apart from broad market, index funds may also track a sector, theme, factor etc. Index Funds which tracks a particular investment factor like value, growth, volatility, momentum etc. are known as smart-beta funds.
What is Factor-based Investing?
Factor investing is an investment approach that involves targeting specific drivers of return across asset classes. Factors generally helpsin explaining returns and risk within asset classes.The approach is quantitative and based on observable data, such as stock prices and financial information, rather than on opinion or speculation. Few examples of factors may be – Value, Growth, Volatility, Momentum etc.
Broadly, momentum investing is built on the simple premise that stocks that have gone up or down, will continue to go up or down, at least in the short term. Therefore, buying a portfolio of such stocks should mayoffer better returns than the broader market. Such an approach carries a generic belief that,price is the king and is the true reflection of the investors' sentiments towards the stocks.”
However, constantly finding recent winners and tracking such stocks may not be possible. And that is where an Index based on Momentum factor may be helpful. In India various strategy based indices are available which captures the performance of factors like volatility, quality, growth, value, momentum etc.
One such index is Nifty 200 Momentum 30 Index which aim to track the performance of 30 high momentum stocks which are part of Nifty200 Index. It has been created and maintained by NSE Indices Ltd., a subsidiary of the National Stock Exchange of India Limited (NSE), with a base value of 1,000 on 1 April 2005. The index is reviewed and rebalanced on a semi-annual basis in June and December each year.
How it Works?
The stocks forming part of the Nifty200 Index and which are also part of derivative segment are eligible for inclusion in Nifty200 Momentum 30 Index. Further, stocks based on their 6 months and 12 months’ volatility adjusted returns - known as normalized momentum score - are considered to be part of the overall portfolio. Top 30 stocks having highest normalized momentum score make the Nifty200 Momentum 30 Index. Weight of each stock is decided based on factor tilt method i.e. at the time of rebalance, weight is decided based on momentum score and free float market capitalization. The weights are capped at an upper limit of 5% at the time of rebalancing. Detailed methodology is available at www.niftyindices.com
Benefits of investing through such momentum based index.
-It helps in constructing a portfolio that systematically add relatively performing stocks and remove relatively non-performing stocks, based on pre-defined criteria, without individuals’ intervention.
-Addition and removal of stock is majorly driven by movements in prices of stocks, which is reflection of market trend.
-It helps in largely reducing subjective biases by adding winners and removing laggards based on well- defined processes*
Who may consider momentum investing?
Momentum is aggressive investment style and is relatively riskier as compared to broad market indices and other factor based investment styles. It may undergo period of relative underperformance when there is sharp change in market cycles like sharp recovery or sharp drop. New investors may consider investing in broad market indices like Nifty 50 or Nifty Next 50 before investing in such smart beta or factor based investment products.