- Wealth PMS (50L+)
In this episode, Shray and Anoop discuss momentum investing and how we implement it as portfolios at Capitalmind.
Defining Momentum Investing
Testing the Evidence for a Particular Investment Strategy
Why Momentum Investing Works: Two Schools of Thought
The Downsides Of Momentum Investing
How Capitalmind Manages Its Momentum Strategy
The Upsides Of Momentum Investing
Capitalmind Offers Two Momentum Strategies
Finally, no strategy is right for everyone. The right strategy for an investor is one that, given their temperament, (s)he can stick with for long enough to gauge its effectiveness.
Hi everyone! and welcome to Episode 33 of the Capitalmind podcast. The investing question that’s on my mind the most, and the one we also seem to get asked most often is whether a market crash is imminent and whether now is a safe or even a good time to invest with stocks having crept steadily upwards over the last few months though the economy looks absolutely terrible.
Now to answer this question, I thought we would bring in an unlikely guest, although you’ll soon see the motivations for doing so. I’d like to bring in Anoop Vijaykumar to help talk about markets today. In particular, I’d really like to point out Anoop joined us a year ago which is when he took when he took over the momentum portfolio at Capitalmind.
And really, what a year it has been. The momentum portfolio has done an astonishing 43% in the last six months. But more importantly, in the last year, it’s done something like 33%. And when the crash happened back in March, this so-called risky and trading heavy momentum strategy- it fell less than half of what the NIFTY did. Now that got all of our attention. Customers were super-interested, pleasantly surprised and we’ve got a lot of inbound interest.
Why I really decided to bring Anoop in here today, is most folks like myself when we first hear about momentum, we think it’s this risky high-churn portfolio that really won’t work for me.
But when you look at its performance and how its risk management works, it really has a very different appeal than what I thought it would, so I thought we should dive into this further. So Anoop, welcome and let’s just get started? I know there are many definitions out there, so can you tell us how do you think of what do you? How do you define momentum investing?
Thanks Shray! After that generous introduction, I think I should quickly start with the mutual fund disclaimer that you know, past returns are not an indicator of future performance. With that said, I think momentum is almost deceptively simple in terms of how you define it. It’s really just that the prices of assets that have gone up in the past will continue to do so in the near future.
There’s really I think, two ways that momentum gets defined, especially in an academic sense, which is time series momentum and relative momentum. Time series is purely about comparing an asset’s return or an asset’s price, to itself in the past.
There are two ways that momentum gets defined, especially in an academic sense, which is time series momentum and relative momentum.
For example, if TCS and Wipro both had positive returns over the last year and beat, let’s say standard FDs (fixed deposits), then we would say they have positive time series momentum.
Relative momentum would actually compare them across the board to decide which one is the better pick. So if TCS did 8% and Wipro did 6% and both have beaten the fixed deposits, then TCS becomes the preferred pick from a relative momentum point of view. But to boil it down is really about saying what’s done well in the past will continue to do well in the future.
Fair enough, but as you know, look anyone can get lucky in their first year of investing. And given that you’re sort of hanging your hat on momentum as a strategy, can you tell us a bit more? What’s the evidence that momentum works? I mean first in general, and then perhaps looking at India in particular.
I think first let’s try and agree on what we mean by evidence of any particular investment strategy. Let’s say, I tell you that if you were to invest in companies starting with ‘I’, you would beat the market. And if I were to then show you some data saying, here’s how companies starting with ‘I’ have beat the market in two out of the last three years, would that count as evidence based investing? Probably not, so there’s two criteria for any strategy to be considered as having had the evidence to back it up.
One is persistence. Has it worked well over a period of time? And by that you mean you want it to have worked over very fairly long stretches of time, going back decades. And the other is pervasiveness. Has it worked across markets, has it worked across asset classes? And if something meets both those criteria, that’s where it said, you can probably explore it a little more. So now coming back to momentum.
So momentum as unintuitive as it is, it was probably first written about back in 1993. There was a paper by Jegadeesh and Titman, who were professors at UCLA, who looked back 15 years and said, what if we bought stocks that have done well in the last year and shorted stocks which have not done well in the last year, and they found that their returns beat the market quite comfortably.
That got a lot of attention, both from academics and practitioners and a bunch of other papers started coming out. There’s another one called, ‘215 Years of Global Multi-asset Momentum’. This is by two gentlemen named Geczy and Samonov. It also essentially looked across markets and asset classes to see how momentum works.
But if you’re a beginner or someone who’s not really been exposed to the concept of momentum, I think this paper called ‘Fact Fiction and Momentum Investing’ by AQR Capital Management’s Clifford Asness and his team, is probably the most understandable at first feed. It essentially concludes that momentum, if you buy stocks that have done well in the past, then your returns are likely to be better than what the market does now.
The essence of momentum investing is basically this – if you buy stocks that have done well in the past, then your returns are likely to be better than what the market does now.
The interesting thing here is Cliff Asness was a doctoral student at the University of Chicago back in 1994, and his dissertation advisor was Eugene Fama- the person who won the Nobel Prize for the ‘efficient market theory’.
Think about it for a moment, where his student essentially went out, did a bunch of analysis, and came back with a conclusion saying that momentum works, and it essentially contradicts the efficient market theory. And to Fama’s credit, he didn’t dismiss it, although I’m not quite sure how he reacted to it when he first came to know about it. But over the years Fama went on to add a disclaimer to efficient market theory saying that momentum is the premier anomaly.
So if you put it all together, you’ve got some fairly solid academic chops who looked at momentum, examined it, questioned it, and then come out and said that look, it seems to work. Having done this so we said, let’s look at it from an Indian point of view, right?
And we went ahead and did a little bit of a backtest for Indian stocks going back to about 2000. That’s not really that that long, but unfortunately that’s what we have here in India. And we try to make sure that our data was free of any survivorship bias, it included everything that had done well, not done well, and looked at applying liquidity filters to make sure that we were only picking stocks that were actually investable, and our finding, again, was consistent with what all the other momentum papers have said, that investing in a portfolio of stocks that have done well in the recent past helps us beat the market.
We, in fact, published this as an SSRN paper. And it’s available for free download on the SSRN website. We will put a link to that paper in this podcast as well.
Yes, that was quite an impressive white paper. While you were saying this, I was feeling a strong sense of deja vu because of the conversation I had with Sundeep Rao, another team member on the Chase strategy. He had mentioned some of these papers as well. I think I’d asked him this question too and I really wanted to get your thoughts on this.
When people talk about technical analysis like this…I’ve heard it at least at one of my previous jobs and maybe even in one of those Berkshire Hathaway conferences. I’ve heard people say that using technical analysis or doing data crunching to analyse the future, that’s a bit like driving by looking in the rearview mirror.
So I’d like to ask you why do you think this works? I mean, what’s your best theory around it?
I think the short answer is, I don’t think anyone really knows why momentum works, although there are a few theories as to why it works and they come down to two schools of thought. One is ‘risk based’ and the other is ‘behavioural’.
Risk based is fairly straightforward. It’s essentially saying that your returns from momentum is higher than the market because you’re taking on more risk. This makes sense and is true to an extent, but I don’t think it completely quite explains it.
The other school of thought in behavioural. Here is where you know you come down to using some of those biases that we’ve started reading about. One of them is ‘under reaction’ and the other is ‘disposition’ and I’ll come to another one, which I think also has a play in in momentum.
So what is under reaction? Imagine there’s a company that’s not really done very well for the last year or so or the last couple of years, so the stocks not really gone anywhere. It’s not being talked about on CNBC. No analyst is really writing great buy reports on this stock.
And then it has a decent quarter. Nothing great, but its slightly better than what it was. No one really notices. You know life goes on. It has another good quarter. Maybe the folks who are closest to that company, closest to that sector start to notice and they say, ‘hey! maybe something’s happening here. Something is changing’.
So people take a little bit of a small position in their portfolios. The stock moves up a little. Another quarter goes by. It now has done reasonably well, fundamentally. Now it starts to appear on the radar of a few other analysts and a few other folks who follow that industry and they start to buy. It is like a circle with the company at the centre and the distance from that company being people who understand and know that company.
Over time, as the information percolates through the market, people start getting more and more positive and optimistic about the company and start adding it at different stages which essentially is why you know that stock would then start moving from let’s say 100 to 160-170, over the course of 15 or 18 months and so there is that one.
I would almost call it ‘information asymmetry’ where people who first knew about the improving fundamentals started buying and then other people got in the know and they started buying.
Then I think there’s one more factor at play here which is the ‘disposition effect’, which is that we hate losses, and I think, even more, we hate losing our gains. So think of the few folks who held the stock when the stock was at its bottom, which meant they had a bunch of unrealized losses in their portfolio, which they hadn’t yet sold to close out. As the stock started rising and then hit their buy price, they were able to quickly get out at break even.
We hate losses, and I think, even more, we hate losing our gains
And I’m sure we’ve all done this way. We have held onto a stock in order to get out of break even. And then as it further goes up, at every stage there are people who are trying to book losses. They’re trying to lock in their gains, be at 20%, 50%, 70%, whatever that is. And that selling almost acts like a natural break on the price of the stock. It doesn’t let it go up too fast too soon.
It gives something like a momentum strategy, an opportunity to get in, not necessarily at the bottom, but at some stage after the rise in the stock has begun and then to hold it for as however long that momentum lasts. So the combination of those I think, explains most of momentum.
And then there is a third effect, which I think applies to very small percentage of stocks that get into momentum portfolios, which is ‘overreaction’. This is mainly where a stage where anything that a company announces is seen as a positive. So I take the example of, let’s say a Microsoft, which I mean it’s obviously been doing extremely well on the back of its cloud business. But then a few months ago they announced that they’re going to be launching phones and tablets (dual screen phones and tablets) and the market really applauded that move as well.
But if you look at Microsoft history, going back to the late 90s, they have a terrible record of launching mobile phones- right from the Windows operating system, Windows CE operating system, followed by the Windows Phone and their acquisition of Nokia, and then subsequent attempts at launching Android phones. They’ve all been pretty terrible.
And yet here is the market, after the company’s been doing well for a while on the back of other businesses, when it announces phones and tablets, everyone gets excited and says, ‘oh, that’s a fantastic positive.’
Now let’s come back closer to home. I mean, we’ve got Reliance as a classic example. I think from 2009 up till 2017, the stock went nowhere and the company was doing pretty much what it does now. As in it was entering new businesses, it was making acquisitions, it was divesting certain assets. But no one was interested.
Suddenly in the last year or so they’ve started acquiring companies. They started selling stake to institutional investors and everyone is really excited about them. If tomorrow, Reliance were to announce they’re getting into the electric car business, I’m sure the stock would bump up 20% based on the optimism without anyone caring whether or not they can actually execute on that.
So there is that element of euphoria and over reaction that happens with a few stocks in a portfolio. And if you hold a bunch of different momentum stocks, couple of such stocks can really make a huge difference to your overall performance. And that’s why I think overall momentum works, at a portfolio level, where some stocks do extremely well, some will do OK and some others will just be negative.
That was very persuasive. Thanks for that. You know, when I go around telling people about momentum, one of the first reactions is ‘maybe this isn’t really for me’. I mean, it takes us a little more time to understand, some of the limitations are kind of obvious. So in your mind, what are the true downsides of momentum? I mean, all the shortcomings of the strategy?
I think there are some real downsides, and there are some ‘perceived’ downsides, the way I look at them. The first real downside is, momentum is a fairly active and it’s a high-churn strategy, meaning it is going to be moving in and out of stocks fairly regularly. This doesn’t work for a lot of buy and hold investors would like to make their buy decision and then not revisit for five or ten years.
There are some real downsides, and there are some ‘perceived’ downsides to momentum investing.
So it is fairly active and therefore it’s not for everyone. The other is momentum never actually will manage to buy at the bottom and sell at the top, which is essentially the Holy Grail. But because of the fact that momentum relies on recent history to decide whether or not to buy a stock, it will have to wait for a stock to rise a little and it will have to wait too for a stock to fall a little before it sells. So those are two real downsides to it.
The other is more perceived. It’s unintuitive. If I tell you that look, here’s a strategy that buy stocks which are trading for far less than what they’re worth, which is the intrinsic value, and we buy them and hold them for a long time, and these are exceptional companies, that makes a lot of sense. You know, it’s very intuitive to all of us.
If I tell you I’m going to buy stocks which are making new highs, and I’m going to hold them, till they make even higher highs then that’s a little hard to stomach for most people. Therefore it’s hard to commit to a strategy that is going to be buying expensive stocks and then holding them for even longer.
Anoop, I know I’ve seen many folks out there with different variants of the momentum strategy. In fact, I think there’s a momentum mutual fund coming out as well. I wanted to ask you about the specifics of how you look at it. How do you or the team manage the momentum strategy at Capitalmind? Could you just tell us a bit more about your rules, processes and so on?
Sure. That is a great question, because momentum is the overall umbrella, but I think the devil is in the details as to how it is implemented. Conventional momentum is fairly high beta, as it tends to rise more than the market. It also falls more than the market, and there’s a problem with that.
Conventional momentum is fairly high beta, as it tends to rise more than the market. It also falls more than the market.
I mean, a strategy that falls, loses 60 to 70% of its value is going to be really hard to stick with. One thing that we tried to do was we went back and tried to see how is it that we can potentially reduce the downside that a strategy like this suffers when markets go down. We did two things which I think have been working reasonably well so far.
One is position sizing. We look at allocating only between 3 and 4% of our new stock to a new stock that enters the portfolio. And we ensure that once it goes up beyond a certain point or weight in the portfolio, we again prune it back to reasonable level. That way we are not overly exposed to any one or two stocks in the portfolio that has worked well.
The other is exit rules. The fact is, we have clear defined exit rules for any stock. And I think exiting stocks is not something that’s talked about enough in pretty much any kind of strategy, be it value, fundamental, growth or momentum. We are fairly clear that once a stock fails to meet those criteria (to stay in the portfolio), we just exit and we don’t mind the fact that stock then after exit might still go on to deliver another 30% or 40%. That’s a trade-off we’re OK to make.
And if you were to go back to what happened in March this year, essentially given the speed of the fall, given the breadth of the fall across the market, our downside measures were all tested to the extreme. And it turned out that in late February and early March, when the market had lost all momentum, our strategy allocated out of equities. We were 100% allocated and then we went from 100% to just over like 15% into equities and the bulk of the remaining in cash and gold. And then we stayed that way for most of March and early April and only started redeploying back in April and May when the market started rising.
So as a result, if you look at our portfolio performance, we fell for less than about half what the market fell during March, which in a sense, give us a hell of an advantage in terms of then outperforming. So once your downsides are contained, I think it’s much easier to deliver outperformance than if you’re losing as much as the market is.
Once your downsides are contained, I think it’s much easier to deliver outperformance than if you’re losing as much as the market is.
Completely agree, and two quick points on that actually. That was, if I may call it, trial by fire because you had published that very impressive white paper with those exhaustive backtests. I think it was what in December or January. And we were all like, well, this is interesting, but momentum always does well when the markets going up. So let’s see how this does when things actually fall.
I mean, in a sense the strategy lived up to the hype and was able to really have shine in what was otherwise a very difficult environment, and so that really did help.
But the second point I’d like to bring out is, this is why I feel it’s important to have this conversation now because so many of us are, as you just pointed out, looking at gains in our portfolio and looking outside with the economic devastation and just getting unnerved by the gap between the P&L in our portfolios and the economic pain going on.
And we’re wondering whether we need to exit, and I think your point around ‘exit rules’ is well taken because of a portfolio like momentum at least has some reasons why it could help you sidestep, limit or sort of hold your own during the next crash, whenever it might come, and so that’s why I feel this timing is fairly important.
I’d like to just shift gears a bit. I guess many of us have been brought up with literature on buying for the long term, buy and hold and so on. What would you say to say, people who consider themselves long-term investors or serious fundamental folks and who feel the companies need to be some combination of ethical, using their balance sheet well, and have all this literature fed into them which either influences the investment choices or the fund manager decisions.
What can you say to them that you think might get them to a shift from their world-view a bit and consider momentum and its pros.
Firstly, I won’t try to convince anyone too hard about any kind of investing. There’s this interesting quote by Tolstoy in one of his books, where he says ‘every happy family is alike but every unhappy family is unhappy in its own way’.
I would actually reverse that for investing and say that ‘every successful investor is actually successful in his or her own way and every unsuccessful investor has a lot in common with each other’. The point being that there are many ways of making money and an investor should pick the way that makes the most sense to them and is essentially suited to their own temperament.
The point is, there are many ways of making money and an investor should pick the way that makes the most sense to them and is essentially suited to their own temperament.
If momentum doesn’t make sense to you at a fundamental level, or you know at your core, then it’s probably not something you should invest in.
Having said that, if you are a fundamental investor, someone who invests on the basis of balance sheets and cash flows, what you’re essentially counting on is that you know more about a company or sector than the market.
For example, if you pick a company that the market currently is valuing at 20,000 crores and you believe it’s worth 50,000 crores, you’re buying it with the assumption that the market is somebody going to agree with you and you’re going to make a 2X return on that company.
Now let’s think about what needs to happen for you to be successful there. It means that you need to know more about that company. You need to know more about what the management is going to do, what plans they have, how they’re going to deploy their capital, and plus maybe a few other variables like interest rates and how they’re going to do in the medium to long-term. Which is great when you get it right. You know it’s very satisfying when you are able to get a fundamental company right. But it’s also bloody difficult to do.
Momentum, on the other hand, is almost like the intellectual opposite of fundamental stock picking. And it does not try to figure out what the market has not figured out. It relies on the market to tell you.
Momentum is almost like the intellectual opposite of fundamental stock picking…it does not try to figure out what the market has not figured out. It relies on the market to tell you.
It relies on the market to tell you which companies are going to do well and which companies are doing poorly. And we we’ve done some research. We’ve done some data analysis on companies going back five years. We looked at about almost 2000 companies listed on the NSE, and we looked at how they did over a period of five years.
The finding was that out of the entire sample set, only about 30% of the companies do well. The remaining 70% tend to provide very disappointing results. 50% actually lose you money. 20% barely beat cash, which is they will beat like a savings account return and only the remaining 30% are the ones that will give you significant returns. So you really have to think about what are the odds that you’ll be able to find companies in those 30%.
Which is where momentum which doesn’t try and forecast or try to predict, comes into play. Since we rely on the market to tell us which industries and sectors are doing well, for example, when after the mass correction when we started redeploying into momentum, it was the former stocks that started showing momentum before any other sector.
So without having any understanding of how the pharma sector is going to play out, momentum allocated to Pharma. This was then followed soon after with agrochemicals and then till recently it was mainly those two sectors and then over the last few weeks it’s been IT and auto that has been showing some momentum.
So without really trying to explain whether these sectors are actually doing better, momentum allocates to them, and it’s not trying to outsmart the market. It’s really just trying to ride on the coattails of the market.
Momentum is not trying to outsmart the market. It’s really just trying to ride on the coattails of the market.
Which is why, if you’ve been a fundamental investor for a fairly long time, and you know what your returns on, and if you think those returns could be improved, it’s worth thinking about allocating some part of your capital to something like a momentum, which is a purely rules-based systematic strategy and see how that does make sense.
One quick question came to mind. You know, when one of the more controversial products Deepak launched at Capitalmind was the market index portfolio where he said it makes sense to buy a bunch of these ETF’s and not try to stock pick and then gets a lot of pushback from customers or just from folks out there.
And intellectually as well, I mean you have all these articles about how if these passive and index approaches end up taking over the world, it will be anything from communism to the end of stock markets.
If momentum investing gets too hot or too big, do you think this could also be a potential risk where if too many people pile into momentum, it could absolutely devastating strategy for these investors or wreak havoc with the stock market?
You know, that’s what logic would suggest, you know. Once everyone knows about a certain strategy and the fact that it does well, it should stop working. But it’s funny because after the 93′ papers, for example, there was a bunch of study done on returns from momentum before and after the first big paper on momentum came out (the 1993 paper by Jegadeesh and Tittman). And it essentially compared momentum returns 10 years before and 10 years after that paper came out, and it turns out, the returns ten years after the paper came out, were actually higher than the returns 10 years before.
So in spite of the fact that everyone knew about this, momentum seems to have done well and obviously in the US. Now you have several momentum ETFs that are deploying a similar strategies.
It seems to have managed to be persistent in spite of the fact that a section of the market has known about it, and has started speaking about it. Yeah, it’s impossible to predict, but I would think that human behaviour is not going to change that dramatically.
The tendency to not buy a stock that has not done well, where the company is not done anything for awhile and then has only now started to do well or buying a stock that has gone up, 30-50% in the last 12 months, is going to be equally hard today, as it was, 20 years ago. So I would expect momentum to last, but obviously there’s no guarantees.
The tendency to not buy a stock that has not done well..and has only now started to do well now…is equally hard today, as it was 20 years ago.
Understood. So I know you have a couple of different variants of momentum out there, right? You run one version of the strategy in the premium service for do-it-yourself customers, and another one for wealth management customers in the portfolio management service. Could you tell us a bit about what’s the difference between these two?
And I’m asking this specifically so that if someone listening to this is interested and wants to give this a shot. How should they consider these two different options for them?
Capitalmind Offers Two Momentum Strategies
The core philosophy (behind the momentum strategy for premium customers and Capitalmind wealth customers) is the same. The differences in the execution. In the premium, because it is a model portfolio and we’re giving out recommendations that are subscribers need to implement on their own. We do it at specific duration of time, so we used to do it monthly. We actually then brought it down to weekly updates where instead of taking the risk of doing the entire rebalance on one day in the month, we spread it out over the course of the month.
So we make changes in the portfolio every Monday. While in the PMS, we have no such restriction, I mean we can essentially take action every day of the week depending on how things are going. That’s one.
The other is in terms of the nature of stocks. In order to keep the minimum lot size in the premium portfolio manageable, we avoid adding stocks which are really high price. If you think purely mathematically, a ₹10,000 stock that is 5% of the momentum portfolio means a minimum lot size of two lakhs which then becomes untenable for a lot of people.
We avoid putting in that ₹10,000 stock and instead pick some lower cost stocks. The PMS has no such restrictions, given the ticket size we are operating with, so we can buy pretty much anything that we want.
I think, the third difference would be in terms of how we exit or enter a stock or in the PMS we again choose to scale in and scale out of positions wherein we might sell start selling a stock and sell parts of it over the course of a week. While in premium, obviously it’s a hard sell or a hard buy where all of it is done on one day. So, those little factors mean that the PMS has a few minor advantage from an implementation point of view.
Understood. Anoop, with that I think we’re ready to wrap up now, so thanks very much for sharing that with us. This is been actually fascinating and like everyone else, I stare at this with a combination of admiration and a bit of disbelief.
But I really felt we needed to bring this conversation out here, because given the way stock markets are, all of us feel a bit nervous, and I think a strategy like momentum or an approach like momentum could help you feel a little calmer about the future, because you’re not tied to a narrative of a certain kind.
A strategy like momentum or an approach like momentum could help you feel a little calmer about the future, because you’re not tied to a narrative of a certain kind.
With that, Anoop, we will definitely link to that white paper you put together. Some of your content, we will list them all in this podcast notes after we’re done, and we’ll even share some performance data so people can take a look at this at their convenience.
Thank you very much and thanks everyone for listening. I wish Anoop and us, a lot of luck and hopefully you’ll find this interesting and you will read up more about it. Stay safe and hopefully momentum sidesteps the next crash as well.