At Capitalmind, we run a Momentum Portfolio as part of our advisory offering. We are also the only PMS to offer a Quantitative based Systematic Momentum Strategy to our clients at Capitalmind Wealth. With markets seemingly going down a rabbit hole, one of the questions we have encountered is whether one should quit the portfolio and wait it out.
When the sea is rough, you don’t want to sail out to catch fish for the risk of the boat toppling is high. Yet, it’s also a time when there is very little competition which means when the storm is over, your net is the only one around netting a bonanza. This of course is based on the assumption that your boat survived the tough times.
Every Portfolio is a set of stocks that is selected based on it meeting certain criteria. A value portfolio for instance will have stocks have good financials but for whatever reason has been ignored by the market resulting in it being relatively cheap – the key here being relative.
A Momentum portfolio on the other hand selects stocks with the best price momentum on a certain look-back. While you can choose anything between 6 months to 18 months, we have chosen to look back 12 months based on extensive testing.
As much as the markets are down, not everything is down and out. This allows us to continue to run a fully filled in Momentum Portfolio even as much of the market meanders downwards. When markets start to turn around, the best performance initially comes from stocks that are beaten down the most with the next best coming from the good stocks that refused to fall. But as the trend holds its own, beaten down stocks which experienced a dead cat bounce generally fail to cross major hurdles and tend to reverse while the good stocks continue on their journey higher.
Momentum strategies can be modeled in two distinct ways
The first is to model them based on Time Series Momentum. Time Series Momentum is applied not at Portfolio but at Individual Level. The Quant Series that is being written (Link) is an example of how to apply time series momentum to Nifty Futures.
The basic idea here is to tell us whether we need to go long or short at that juncture based on the variable one uses.
The second is to model them based on Cross Sectional Momentum. In this scenario, you rank stocks on pure returns with the list starting with the best stock and ending with the worst. Execute by buying the best and rotating at regular intervals. What we practice is Cross Sectional Momentum.
Momentum is mean reverting at extreme short term and again at extreme long term. This understanding from data has meant that we have chosen to lookback for a period of 1 year and re-balance on a monthly scale. Choosing to rebalance annually or quarterly or monthly or even weekly is more about signal decay and turnover. For instance, if one were to re-balance on a quarterly versus monthly, it may reduce a bit of churn but introduces decay. On the other hand weekly rebalance adds a lot of avoidable churn.
Our benchmark is Nifty Alpha 50 even though the fact that you cannot invest in the same for lack of options in Index and ETF. This index is rebalanced quarterly. This delay in rebalance combined with the Universe being limited to the top 300 companies by market capitalization has meant that it continues to have companies like Vakrangee (down 94% from Peak).
Just Dial and Adani Power both find themselves in the index thanks to they hitting new 52 week highs even though both of them are down nearly 60% from their all time highs even today. Our testing has shown that 52 weeks are good but all time highs are better.
It’s one thing to get caught in a wrong stock and quite another to stay wrong. By using the entire universe of stocks that are available, we reduce that risk though given that even big stocks have and continue to go kapult, there is no saying that we shall never get caught in something similar.
Another method that looks interesting is applying a trend filter (Time Series Momentum) on the Index, say the Nifty 50 and take a decision on whether to continue to buy or hold / sell the portfolio when it triggers a sell.
For example, using a 200 day EMA for instance can see a reduction in draw-down, but like any other indicator, there are risks involved. Let’s assume that we propose a strategy that shall cut the portfolio and move to cash when Nifty 50 drops below the 200 EMA. In between November 2018 to March 2019, the strategy whipsawed 5 times. Whatever may have been the savings in risk would have been completely eroded here.
The basic philosophy of Momentum doesn’t lie in removing all risks of negative returns. Other than keeping money in a fixed deposit, any risk taking venture is bound to have bad days despite the best of effort. Rather, the idea behind investing in Momentum strategy is to eliminate the risks of getting caught in stocks that tumble down before any bad news is out.
Also, since both our Portfolio’s consist of 30 stocks, this diversification ensures that one or two bad apples even if they some-how enter our portfolio cannot have a big impact. Without any additional trades or filters, we are able to ensure tail risk hedging just by widening our portfolio size.
While Momentum may seem like a more volatile strategy, in truth, both in performance and volatility its comparable to Nifty Midcap 100.
On the absolute return front, both Nifty Midcap 100, Nifty 50 and Nifty Alpha 50 have delivered similar returns if the peak of 2008 is taken as the starting point. The paths have diverged at various times though today we see convergence of the same.
The decay in signals for Nifty Alpha 50 and the restriction in market capitalization are two factors we believe will enable us to provide a better return than either. While today, it looks like investing in Nifty 50 may be the no-brainer option, when you look back at historical trends, Nifty 50’s median 3 year return has been to the tune of just 10%. Against this, Nifty Alpha 50’s is 15%.
There has been a truck-load of papers that showcase Momentum working not just in other parts of the world but also in history going back as far as data can support. The only thing that is lacking though is the Narrative that accompanies investments.
Saying a model picked up my stocks sounds less sexier than saying how one having studied the business and the promoters decided to bet with them. If you are game for that, Momentum is something you should at the very least consider as a small part of the portfolio for it provides negative correlation with value factor and low but positive correlation with growth and quality factors.
While the markets are definitely weak, there are still pockets of performance. As on date, nearly 200 stocks still qualify post our filters allowing us to have a complete portfolio and not having to move to cash for lack of availability.
Do ping us if you have any queries. If you are a premium member, we can be reached on Slack in #trading-room.