Mutual Funds Strategy 114: Momentum Vs Value Investing
In the early days of Investing, there was only one style: Value Investing. In this style, you buy something cheap relative to the rupee and hold on to it until you get a decent return. In the long run, this strategy worked really well as stocks that traded below their fair value recovered and gave above-market returns.
Buying cheap stocks does not always mean it is a bargain buy. Some companies may be literally cheap, which is why their stocks are trading at a discount. If you buy them, the chances of losing money are 99/100. So it takes an analytical brain to comprehend if the companies are actually cheap or if just their stock prices are cheap.
Momentum Investing is a newer concept. It simply means you are finding the fastest horse in a race and betting your money on that. The logic is that what is performing superbly will continue to perform well. The speculators and traders usually follow this approach to make quick money. They buy the winners, hold for a short period, and then exit.
Just ask any stock trader why they purchased a stock XYZ today. They would say, “It’s because XYZ can go up 10% from the current levels”. And when it goes up 10%, they book a profit by selling this stock. This is pure momentum play.
The two overarching themes of fear and greed are evident in value and momentum investing, respectively.
When the market falls, stocks crash — people usually exit in fear. If you start investing during this capitulating period, you become a good value investor as most of the stocks would be near their lows and significantly below their intrinsic value.
When a stock goes up 10%, people get greedy and start buying with the hope that someone else may buy it at an even higher price. This is momentum investing for you. As long as the stock goes up, people will be ready to bet more money on that. This is an upward spiral and sometimes the valuations could get really crazy.
Let me also tell you how to find a value stock and a momentum stock using technical tools.
For Value Investing, use tools like
- P/E (Price to Earnings)
- PEG Ratio
- P/B (Price to Book Value)
- Check the operating margin.
- Check for profitability and growth.
For Momentum Investing, use tools like:
- RSI (Relative Strength Index)
- MACD
- ADX higher than 40
Both these strategies are not immune when it comes to losses. You could lose money in value investing just as much as in momentum investing. When it comes to stocks, the uncertainty is higher and if you have a concentrated bet, your entire capital could get wiped out. This is where mutual funds fit in. Even if the theme is value investing or momentum investing, mutual funds always diversify.
So if you buy 1 to 2 stocks, mutual funds will buy 20 to 30 stocks with the same money. Obviously, MFs do not buy fractional shares, but since they have many investors like you, they combine the money and buy a basket. This diversification will help them control the intensity of losses. Even if a stock in their basket falls 40% and it has a 2% exposure, the final damage is negligible.
The downside of diversification is the locking out of lottery-style winning returns. If a stock had 2% weightage and its value doubled, the overall benefit you are getting is negligible. Instead, if you had put all your money in that stock, your net-worth would have doubled.
Let us look at some popular value vs momentum mutual funds.
The CAGR returns are strongly favoring the value fund. One of the reasons for this is the current 15% fall of Nifty from its top. If you had taken the same snapshot in July or August 2024, the momentum fund would have won it easily.
The takeaway is that momentum will work only in upward-trending markets. A boom is the best friend of momentum investing, people will be optimistic, a bit greedy, and willing to commit funds.
The time horizon is also another factor. If you wish to speculate the current market but do not dare to go with stocks, then you can trade/invest via momentum funds. They do well for 3, 6, 9, and 12 month period. On the other hand, if you wish to invest for the long term (horizon undefined), then the value fund will give you a better bargain.
You could also mix and match the total funds as a ratio, for example
- 60% momentum, 40% value, i.e. 6000 into a momentum fund and 4000 into a value fund for a total of 10000 investments.
- 30% momentum, 70% value, i.e. 3000 into a momentum fund and 7000 into a value fund for a total of 10000 investments.
- 15% momentum, 85% value, i.e. 1500 into a momentum fund and 8500 into a value fund for a total of 10000 investments.
The next best option is to update your screener to have both momentum + value criteria (This is too hard to digest as of now, will write about it some other day).
Hope you got some insights into momentum and value funds today. If you liked this article, consider sharing it with your friend or relative who could benefit from this.