The momentum factor has been topping value this year and that has helped the iShares MSCI USA Momentum Factor ETF (NYSEArca: MTUM) to a year-to-date gain of 7.6%.
MTUM, which tracks large- and mid-cap U.S. stocks with relatively high price momentum. The underlying MSCI USA Momentum Index calculates the ratio of each stock’s price returns over the trailing 13 and seven months against volatility over the past three years. Companies are then weighted by their risk-adjusted momentum. [Expanding Economic Conditions Should Favor Growth Stock ETFs]
MTUM’s underlying index reconstitutes holdings only twice per year in May and November, and includes a broad buffer to diminish turnover and potential transaction costs.
Potential investors should be aware that the momentum strategy typically works well under sustained market rallies and could breakdown during volatile conditions. For instance, the underlying benchmark underperformed the MSCI USA Index by 3.8% during the 2008 financial crisis.
“Momentum is different from the volatility of a stock. In simple terms, momentum is the rate of acceleration of a security’s price or volume. It’s very helpful, even more than moving averages, when used in combination with another indicator to estimate the future movement of a share,” according to Market Realist.
Moreover, since momentum strategies can overweight riskier stocks, the ETF could could underperform during another correction. Since defensive stocks typically do better during volatile conditions, the momentum strategy could load up on conservative picks and miss out on the initial recovery in riskier assets.
However, MTUM is among the many momentum ETFs that prove momentum can mean much more than just a high beta from a sexy sector. Momentum can also mean an emphasis on relative strength and strong price characteristics. [Index Changes Lift These ETFs]
In MTUM’s case, this is how the momentum factor is applied: “At each rebalance, a risk-adjusted price momentum is calculated (defined as the excess return over the risk-free rate divided by the annualized standard deviation of weekly returns over thepast 3-years) for each security in the parent index over the trailing 6- and 12-month time period. The 6- and 12-month risk-adjusted price momentum scores are then standardized at +/-3 standard deviations and the standardized z-scores are translated into an average momentum score. Approximately 100-150 securities with the highest momentum scores are selected for inclusion in the Underlying Index,” says iShares. [Momentum Marriage in an ETF]
“A general reason for an investor selecting momentum stocks is that a stock with high momentum will keep following the trend for a longer time compared to other stocks. Momentum stocks also help easily identify a trend,” adds Market Realist.
iShares MSCI USA Momentum Factor ETF
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.