At first glance, the current market environment does not appear to favor momentum strategies and exchange traded funds that adhere to those strategies, such as the iShares MSCI USA Momentum Factor ETF (NYSEArca: MTUM). However, MTUM should not be written off.
MTUM 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.
“Buying momentum (i.e., leadership) on market pullbacks has been an outperforming strategy in recent months, quarters, and years and we expect it to remain an outperforming strategy over the coming months, quarters, and years,” said Oppenheimer technical analyst Ari Wald in a note posted by Chris Dieterich of Barron’s.
Related: A new Momentum Bond ETF
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.[related_stories]
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.