What Makes Momentum ETFs Tick

Due in large part to the ascent of some well-known Internet and technology stocks, the growth and momentum factors have been performing well this year. That theme did, however, recently take some heat as the FANG stocks retreated, reminding investors that they should examine momentum-based strategies before jumping in.

Even with some recent pressure on momentum stocks, the iShares MSCI USA Momentum Factor ETF (NYSEArca: MTUM) is up nearly 19% year-to-date. 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.

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.

“This risk-adjustment should help the fund avoid loading up on the riskiest names during bull markets, which tend to underperform during market reversals,” said Morningstar in a recent note. “It should also increase the fund’s exposure to stocks with momentum that is more likely to persist. This is because stocks with steady price improvement are more likely to enjoy gradual improvements in fundamentals that investors may underappreciate than those with greater volatility.”