The value factor is all the rage these days, but that does not mean investors should forget about momentum and the iShares MSCI USA Momentum Factor ETF (NYSEArca: MTUM).
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.
The momentum factor has struggled, but that could also mean a rebound is on the way.
“In fact, momentum strategies were among the poorest-performing diversified equity exchange traded funds last year. But they could be poised for a comeback,” reports Investor’s Business Daily. “Like value and size, the momentum factor has been shown to historically offer attractive returns over a full market cycle. Unlike those factors, momentum is harnessed by just a handful of exchange traded funds.”
MTUM is up 3.4% this year, a gain that is being fostered by some well-known growth stocks, such as Facebook (NasdaqGS: FB) and Amazon.com Inc. (NasdaqGS: AMZN). Although MTUM holds growth stocks such as Amazon, it also holds older, more docile fare such as Dow components Johnson & Johnson (NYSE: JNJ) and Procter & Gamble (NYSE: PG).
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.
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.
“MTUM tends to hold a relatively small basket of large- and midcap stocks,” notes IBD. “The ETF is overweight the economically sensitive technology sector, at a 39% portfolio weighting. A low 0.15% expense ratio gives the iShares momentum ETF a cost edge over its rivals.”
For more information on alternative index-based exchange traded funds, visit our smart beta category.
Tom Lydon’s clients own shares of Amazon and Facebook.