Momentum & Alpha Index Funds – How do They Work? How to invest?

The concept of momentum is often used in the stock markets, indicating the tendency of high-performing stocks to continue good performance in the short to medium term. The momentum investing factor has caught the fancy of investors globally, especially in the last decade. 

Alpha, also known as excess returns in stock markets, measures a stock’s returns that are higher than what is expected by the market for the asset’s risk category. While this is commonly used by stock market investors to target manifold returns in their portfolios, it is relatively new in the form of Alpha index funds in the mutual fund market.

Here, we will explain the concepts of momentum and alpha index funds for investors who want to adopt a passive investment strategy.

About Momentum and alpha index funds

Before we learn about momentum and alpha index funds, let’s have a quick look at the meaning of index funds in general.

What are index funds?

An index fund is a passively managed mutual fund with a portfolio that aims to closely match or track the benchmark index components. An example of a benchmark index is the Nifty 50, Sensex, etc. This type of fund offers broader market exposure and comes with lower expenses due to passive management. It also has a relatively lower portfolio turnover. 

What is a momentum index?

A momentum index adopts an equity momentum strategy by focusing on stocks that have a high price momentum. The benchmark index maintains sufficiently high trading liquidity with a moderate turnover.

How does a momentum index fund work?

The momentum index considers stocks that have been outperforming recently and have higher chances of continuing the strong performance in the near future. There can be many attributes why some stocks may be offering superior returns at considerably higher speed and this earns them the ‘Premier Anomaly’ tag.

In India, one of the popular indices based on the momentum factor is the Nifty 200 Momentum 30 Index. This index offers investors exposure to 30 of the high-movement stocks that fall under the large and mid-cap segment of the Nifty 200 index.

What is alpha index?

The alpha index adopts a strategy focused on selecting stocks that have higher alpha or returns as compared to a chosen benchmark. In such indexes, stocks that fetch high alpha consistently over a period are selected.

How does an alpha index fund work?

In India, one of the popular indices based on the alpha factor is the Nifty Alpha 50 Index. The Nifty Alpha 50 Index is a highly diversified index that comprises 50 stocks across the large-, mid-and small-cap segments. The index selects stocks with the highest alpha from among the top 300 companies. 

The alpha index strategy has shown significant returns in the past two years and this is mainly attributed to the sharp rise in the mid-and small-cap stocks. 

Some of the sectors that currently enjoy high weightage in both alpha and momentum indices are: 

• Financial services,
• IT,
• Consumer goods,
• Metals,
• Power, and
• Chemicals

Both momentum and alpha indices have performed better than other benchmark indices across different timelines in the recent past. However, as with any equity investment, high returns are often accompanied by higher risk. These index funds are not spared too as these also witnessed huge corrections during market lows. Momentum and alpha indices tend to experience higher price volatility as compared to benchmark indexes like the Nifty 50. 

Who should invest in momentum and alpha index funds?

These index funds are best suited for the following investor types:

• Investors who are looking to invest in mutual funds with a passive investment strategy can consider these funds.
• Investors who have an appetite for high price volatility and higher downside risk may consider investing in these index funds.
• Alpha investment strategy can outperform by a considerable margin within a few years. Therefore, these are best suited for investors with a short to the medium investment horizon.
• The momentum strategy shows better performance in the long run and lowers downside volatility as compared to Alpha. Therefore, momentum funds may be suited for investors who prefer lower risk as compared to risk related to Alpha funds.
• Momentum indices focus on the top 200 companies with strong corporate governance practices and reasonable liquidity. Therefore, momentum funds can be ideal for investors looking to diversify their portfolios and prefer higher liquidity.

How to invest in momentum and alpha index funds?

Investing in momentum and alpha index funds is very easy. The best way for investors to begin investing in these is to buy fund units through the SIP or STP route. This is ideal for better managing volatility risk during market downturns. 

Experts suggest that investors use a combination of a passive investment strategy with active investment to ensure risk-return balance in the portfolio. Also combining momentum, alpha and regular indices within a portfolio can be best suited for investors who want aggressive returns. Thus, investors who have already invested in a broad market index can consider momentum or alpha investing to further boost returns.

Conclusion

Both alpha and momentum indexes include stocks that have performed considerably well in the recent past. These indexes are based on similar principles but involve different implementation methods. Every investment strategy has various pros and cons. The same goes for momentum and alpha index investing. Staying invested in these for a medium to a longer duration can help investors in fetching good returns.

FAQs