Nifty 200 Momentum 30 Index

Riding the Momentum Wave | 31x in 19 years! – Newton Would Be Proud!

Newton might have never dabbled in stocks, but his principles are alive and well in the financial world. In the Nifty 200 Momentum 30 Index, we see the practical application of his laws of motion, transformed into a strategy that’s all about capitalizing on the inertia of winning stocks. With a portfolio that’s always chasing the hottest trends and the best performers, this index doesn’t just aim to buy low and sell high. Instead, it embraces the mantra of buying high and selling even higher.

So, strap in, hold on to your apples, and get ready to explore the thrilling, high-flying world of momentum investing. Newton would be proud—or at least, he’d be intrigued by how his laws of motion have been co-opted into a strategy that’s as much about psychology as it is about physics. After all, in the stock market, just like in the physical world, what goes up often keeps going up—until it doesn’t. And that’s where the fun begins.

What is the momentum strategy?

Momentum investing is based on a deceptively simple idea: stocks that have performed well in the past will continue to do so in the near future. Think of it as a financial equivalent of Newton’s first law of motion: an object in motion stays in motion unless acted upon by an external force. In the stock market, this means that a winning stock is likely to keep winning—at least for a while. And that’s where the Nifty 200 Momentum 30 Index comes in, turning this concept into a powerhouse investment strategy.

So, how does momentum investing work? Picture yourself at a party where everyone is raving about the latest hot stock. Instead of being the skeptic who waits for the hype to die down, a momentum investor jumps on the bandwagon and buys the stock. He buys the stock at a high price, and then waits for the momentum to push it even higher before selling. It’s a bit like surfing: you catch the wave at its peak and ride it as long as possible before it crashes. If done right, you not only stay dry, but you also come out looking like a genius.

What is the Nifty 200 Momentum 30 Index?

This index is an innovative financial instrument designed to track the performance of the top 30 companies within the Nifty 200 Index, selected based on a normalized momentum score. This momentum score is calculated using the 6-month and 12-month price returns of the companies, adjusted for daily price volatility. The index aims to capture the momentum effect, which is the tendency of stocks that have performed well in the past to continue performing well in the future, and vice versa for underperforming stocks.

What methodology is used to calculate the index?

The Nifty 200 Momentum 30 Index tracks the performance of high-momentum stocks from the Nifty 200 Index. These are stocks with high normalized momentum scores, which are derived by considering both the 6-month and 12-month price returns and adjusting for daily price return volatility.

Base Date and Value

• Base Date: April 1, 2005
• Base Value: 1000

Weighting Scheme

The weighting of stocks in the index is based on a combination of their normalized momentum scores and their free-float market capitalization. This approach, known as the factor tilt methodology, ensures that the weights are proportional to both the momentum and the size of the stocks.

• Cap on Stock Weights: The weight of each stock is capped at the lower of 5% or 5 times the weight of the stock in the index based solely on its free-float market capitalization. This cap is designed to prevent any single stock from having an outsized influence on the index performance.
• Buffer to Reduce Turnover: A buffer is applied based on normalized momentum score ranks to reduce the turnover of the index constituents. This buffer helps to minimize transaction costs and improve the overall stability of the index.

Momentum Effect and Its Significance

The momentum effect is well-documented in academic literature and is often referred to as the “premier anomaly.” This effect suggests that stocks that have performed well recently are likely to continue performing well in the short to medium term, and the same applies to underperforming stocks.

Key Reasons for Momentum Effect:

1. Underreaction to News: Investors often underreact to news, leading to gradual price adjustments rather than immediate changes. This underreaction can be due to behavioral biases where investors are slow to process new information or reluctant to change their existing beliefs.
2. Herding Behavior: As more investors notice the strong performance of a stock, they tend to buy it, further driving up its price. This herding behavior amplifies the price trends and creates a positive feedback loop.
3. Loss Aversion: Investors are reluctant to sell losing investments, causing prices to fall more slowly than they should on bad news. Loss aversion, a concept from behavioral finance, suggests that people prefer to avoid losses rather than acquire equivalent gains.

Performance Analysis

The index has consistently outperformed its parent index, the Nifty 50, both over the long term and in recent periods. This superior performance underscores the effectiveness of the momentum-based stock selection strategy.

Historical Performance

• Data as of August 31, 2020: The index has shown significant outperformance compared to the Nifty 200 Index. Over a 15-year period from its base date, the Nifty 200 Momentum 30 Index has delivered higher returns, reflecting the persistent momentum effect in the selected stocks.
• Recent Performance: Even in the short term, the index has continued to outperform its parent index, demonstrating the robustness of the momentum strategy during different market conditions.

Comparison between Nifty 200 Momentum 30 Index and Nifty 50 Index

The Compound Annual Growth Rate (CAGR) is a crucial metric for evaluating the performance of investment indices over a period. It provides a smoothed annual rate of return, assuming that the investment grows at a steady rate. The Nifty 200 Momentum 30 Index has historically demonstrated a higher CAGR compared to the Nifty 50 Index, reflecting the efficacy of the momentum-based selection strategy.

• Nifty 200 Momentum 30 Index CAGR: Since its inception in April 2005, the index has shown a CAGR significantly higher than the Nifty 200 Index. As of the latest data from June 2024, the CAGR for the Nifty 200 Momentum 30 Index stands at approximately 18.5% per annum since 2005.
• Nifty 200 Index CAGR: In contrast, the Nifty 50 Index, which includes the top 50 companies based on free-float market capitalization without a specific focus on momentum, has a lower CAGR. Over the same period, the Nifty 50 Index has achieved a CAGR of around 13.26% per annum.

This stark difference in CAGR underscores the advantage of a momentum-based investment approach, where stocks with high recent performance continue to drive superior returns.

1 year Rolling Returns

3 year Rolling Returns

5 year Rolling Returns

Data source

Outperformance Metrics

The Nifty 200 Momentum 30 Index has consistently outperformed the Nifty 200 Index across various time horizons:

• 1-Year Performance: In the most recent year, the Nifty 200 Momentum 30 Index recorded a return of 66%, compared to the Nifty 50 Index’s 21.17%. This is an alpha of more than 40% which is a contributing factor to the strategy’s success.
• 3-Year Performance: Over the past three years, the Nifty 200 Momentum 30 Index has delivered an average annual return of 28%, while the Nifty 50 Index has averaged 13% per year.
• 5-Year Performance: Looking at a five-year horizon, the Nifty 200 Momentum 30 Index shows an average annual return of 22.6%, outperforming the Nifty 50 Index’s 13.8%.

This consistent outperformance across different periods highlights the strength and reliability of the momentum strategy employed by the index.

Benefits of the Nifty 200 Momentum 30 Index

1. Exposure to High Momentum Stocks: Investors gain exposure to stocks with strong recent performance, which are likely to continue their upward trend based on historical data.
2. Diversification: The index includes a mix of large and mid-cap stocks, providing diversified exposure across different segments of the market. This diversification helps to spread risk and reduces the impact of poor performance by any single stock or sector.
3. Reduced Turnover: The application of a buffer based on momentum scores helps in reducing the turnover and associated transaction costs. Lower turnover means that the index constituents are not frequently changed, leading to cost savings for investors.

Portfolio Weightage & Constituents

The portfolio composition of the Nifty 200 Momentum 30 Index differs significantly from the Nifty 200 Index, reflecting its focus on high-momentum stocks.

• These weights reflect the recent momentum scores of these companies, ensuring that the index captures the latest market trends and top performers.
• Nifty 50 Index: This index is more aligned with the broader markets. The weights are based solely on free-float market capitalization, without consideration of momentum scores. As a result, the Nifty 50 Index might have higher weights in traditional sectors like energy and utilities, which might not always be the top performers in terms of momentum.

By concentrating on stocks and sectors with high recent performance, the Nifty 200 Momentum 30 Index is positioned to capitalize on ongoing trends, leading to its superior performance metrics.

Evolution of the Nifty 200 Momentum 30 Index Constituents

The dynamic nature of the Nifty 200 Momentum 30 Index means that its constituents are regularly reviewed and adjusted to reflect the latest market trends and performance metrics. This adaptability is a key reason for its superior performance compared to the Nifty 200 Index.

Industry Shifts and Adaptations

The composition of the Nifty 200 Momentum 30 Index has evolved over time to include industries that are outperforming, based on the momentum criteria.

• Automobile Sector: Recently, the automobile sector has seen significant growth, particularly with companies like Bajaj Auto, Tata Motors, and TVS Motor Company. These companies have demonstrated high momentum due to increasing sales, innovation in electric vehicles, and expanding market reach.
  • Example: Bajaj Auto and Tata Motors have shown exceptional growth in their stock prices due to strong quarterly earnings and new product launches, particularly in the electric vehicle segment. Their inclusion in the index highlights the sector’s overall momentum.
• Pharmaceutical and Healthcare Sector: The healthcare sector remains a strong performer with companies like Dr. Reddy’s Laboratories, Lupin, and Aurobindo Pharma maintaining high momentum scores. The ongoing focus on healthcare innovation and pandemic-related developments have driven these stocks.
  • Example: Dr. Reddy’s Laboratories continues to perform well due to its extensive pipeline of generic drugs and strong international sales. Its persistent high momentum justifies its continued inclusion in the index.
• Infrastructure and Construction: Companies like Larsen & Toubro and DLF Ltd have shown strong performance due to increased government spending on infrastructure projects and a booming real estate market.
  • Example: Larsen & Toubro has benefitted from major contract wins and infrastructure development projects, making it a significant component of the index.

Periodic Rebalancing and Turnover

The Nifty 200 Momentum 30 Index undergoes periodic rebalancing to ensure that it continues to reflect the top 30 companies based on the latest momentum scores. This rebalancing process involves adding new high-momentum stocks and removing those that no longer meet the criteria.

• Rebalancing Frequency: The index is typically rebalanced semi-annually. During these reviews, stocks that no longer exhibit strong momentum are replaced with those that have recently shown high price returns.
• Impact on Performance: This regular rebalancing helps the index maintain its focus on high-performing stocks, which is crucial for sustaining superior returns. By continuously adapting to market trends, the index captures the evolving landscape of stock performance.

Case Studies of Constituent Changes

To illustrate how changes in constituents have driven higher returns, consider the following case studies:

• Case Study 1: Inclusion of a Leading Auto Manufacturer: Tata Motors has shown exceptional growth over the past year due to its successful launch of electric vehicles and expansion into new international markets. Its high momentum score led to its inclusion in the index, contributing significantly to the index’s performance.
• Case Study 2: Removal of an Underperforming Pharmaceutical Company: A pharmaceutical company that previously had a high momentum score starts to underperform due to regulatory challenges and declining sales. During the rebalancing, this company is removed from the index and replaced by a high-performing healthcare firm, such as Lupin, which continues to show strong momentum due to its expanding product pipeline and market presence.

General Drawbacks of Momentum Investing

While momentum investing might seem lucrative it comes with it’s own set of drawbacks.

1. High Turnover and Transaction Costs: Momentum strategies often require frequent trading to maintain a portfolio of high-momentum stocks. This can lead to higher transaction costs and increased tax liabilities, which can eat into overall returns.
2. Risk of Reversal: Momentum stocks are prone to sharp reversals. Stocks that have risen quickly can also fall just as fast if market sentiment changes. This can result in significant short-term losses.
3. Market Conditions Dependency: Momentum investing tends to perform well in trending markets but can struggle during periods of consolidation or sideways movements. It is highly dependent on the continuation of existing market trends.
4. Overfitting and Data Mining: There is a risk that momentum strategies are overfitted to historical data, leading to suboptimal performance in the future when market conditions change.
5. Behavioral Biases: Momentum investing can sometimes be driven by irrational exuberance or herd behavior, where investors continue to buy stocks simply because they have been rising, leading to potential bubbles and subsequent crashes.

Nifty 200 Momentum 30 Index Drawbacks and Risk Management

Nifty 200 Momentum 30 Index has its drawbacks despite boasting impressive returns and a track record of outperformance. One of the primary risks associated with momentum investing is its inherent volatility. Momentum stocks, by their very nature, can experience significant price swings. This can lead to periods where the Nifty 200 Momentum 30 Index performs substantially worse than broader market indices. Here are two historical examples that illustrate these challenges:

Drawbacks

The 2008 Recession: A Harsh Lesson in Volatility

The global financial crisis of 2008 serves as a stark reminder of the risks involved with momentum investing. The period between January 2008, to November 2008 was when the recession hit the hardest. During this period the Nifty 200 Momentum 30 Index experienced a severe drawdown of 65%. This was significantly worse than the 55% drawdown observed in the Nifty 200 Index over the same period. The heightened sensitivity of momentum stocks to market downturns can amplify losses during periods of economic distress. In times of panic and market crashes, stocks previously exhibiting strong momentum fell sharply as investors rushed to sell off their holdings. This makes the momentum index more susceptible to extreme drawdowns compared to broader, more diversified indices.

The Sideways Market of 2021-2022: Challenges of a Momentum Strategy

Another period highlighting the volatility of the Nifty 200 Momentum 30 Index occurred from November 2021 to July 2022. During this time, the market was relatively sideways, lacking a clear upward or downward trend. In this environment, the Nifty 200 Momentum 30 Index saw a maximum drawdown of 25%, whereas the Nifty 200 Index experienced a more modest drawdown of 15%. This example underscores how the momentum strategy can struggle in markets that lack a strong directional movement. When the overall market is moving sideways, the stocks that previously demonstrated high momentum may lose their luster. This results in underperformance and greater volatility within the momentum index.

Risk Management

The index employs several risk management techniques to ensure stability and reliability:

• Weight Capping: By capping the weight of individual stocks, the index limits exposure to any single company’s volatility.
• Periodic Review and Rebalancing: The index is reviewed and rebalanced periodically to reflect the latest momentum scores and market conditions. This helps to ensure that the index remains aligned with its objective of capturing high-momentum stocks.

How can I as an investor invest in Nifty 200 Momentum 30 Index?

How to Invest in the Nifty 200 Momentum 30 Index

For investors looking to gain exposure to the index, several mutual funds and ETFs track this index. Here is a brief list:

Exchange-Traded Funds (ETFs)

1. Aditya Birla Sun Life Nifty 200 Momentum 30 ETF
2. HDFC Nifty 200 Momentum 30 ETF
3. ICICI Prudential Nifty 200 Momentum 30 ETF
4. Motilal Oswal Nifty 200 Momentum 30 ETF

Mutual Funds

1. Bandhan Nifty 200 Momentum 30 Index Fund
2. HDFC Nifty 200 Momentum 30 Index Fund
3. ICICI Prudential Nifty 200 Momentum 30 Index Fund
4. Kotak Mahindra Nifty 200 Momentum 30 Index Fund
5. Motilal Oswal Nifty 200 Momentum 30 Index Fund
6. UTI Nifty 200 Momentum 30 Index Fund

These options provide various ways to invest in the Nifty 200 Momentum 30 Index.

Conclusion

The index represents an exciting opportunity for investors looking to capitalize on the powerful forces of market momentum. The strategy focuses on stocks that have demonstrated strong recent performance. As a result, the strategy captures ongoing trends and delivers superior returns. The index does justice to the strategy. The historical data showcases its impressive track record, with the index consistently outperforming broader market indices over various time horizons.

However, it’s essential to acknowledge that with great potential rewards come certain risks. The Nifty 200 Momentum 30 Index is inherently more volatile than its broader counterparts. The drawdowns during the 2008 financial crisis and the sideways market of 2021-2022 serve as reminders of the challenges that can accompany momentum investing. Despite these periods of heightened volatility, the long-term performance of the index highlights the effectiveness of a well-executed momentum strategy.

For investors willing to embrace some degree of risk in pursuit of higher returns, the index offers a compelling proposition. By maintaining a dynamic approach and regularly rebalancing to reflect the latest market trends, this index positions itself to capitalize on the most promising opportunities within the Nifty 200 universe.

In the world of investing, the key is to understand the forces at play and navigate them wisely. With careful consideration and a balanced portfolio, investors can harness the power of momentum to achieve their financial goals. So, while the ride may be a bit bumpier, those who stay the course can find themselves enjoying the exhilarating highs of momentum investing.