Your Questions Answered: I want to invest in the Nifty 500 Momentum 50 Index. Please elaborate on the pros and cons

Q. My wife and I have been investing in debt mutual funds and Sensex tracking index mutual funds for the past 8 years. We now intend to diversify and invest in index funds tracking the Nifty 500 Momentum 50 Index. Can you please elaborate on the pros and cons of investing in such funds? Additionally, please list the differences between the Nifty 50 index and the Nifty 500 Momentum 50 Index.

Krantiveer Waghlaw, Ratnagiri, Maharashtra

What is the Nifty 500 Momentum 50 Index?

The Nifty 500 Momentum 50 Index is a subset of the broader Nifty 500 Index. It selects 50 stocks based on their momentum factor, which measures the rate of change in stock prices over a specific period. This index aims to capture the potential of high-performing stocks while maintaining diversification across sectors and market capitalisations.

The Nifty 500 and Nifty 50 indices are two prominent benchmarks in the Indian stock market, each serving distinct purposes and catering to different investor needs. While both are managed by the National Stock Exchange (NSE), they differ significantly in terms of composition, scope, and investment objectives. Let’s explore these differences in detail.

What is momentum investing?

Before we deep dive into the Nifty 500 Momentum 50 Index, it is important to understand what momentum investing is. Momentum investing is an intriguing strategy in the world of finance that leverages the principle of "buy high, sell higher." It focuses on identifying stocks or assets that have exhibited strong past performance in terms of price movement, with the belief that they will continue their upward trajectory for the foreseeable future.

At its heart, momentum investing is built on the idea that trends in the market, whether bullish or bearish, tend to persist. It relies on the behavioural finance theory that investor psychology and market sentiment contribute to the continuation of these trends. Stocks with positive momentum often attract more attention, driving further demand and pushing prices higher. This strategy contrasts with value investing, which focuses on buying undervalued assets, or contrarian investing, which targets stocks that others might be avoiding.

Eligibility criterion to be part of the Nifty 500 Momentum 50 Index

As mentioned above, the Nifty 500 Momentum 50 Index is a specialised index designed to capture the performance of stocks with strong momentum within the Nifty 500 universe. Its eligibility criteria ensure that only the most suitable stocks are included, maintaining the integrity and purpose of the index.

1. Membership in the Nifty 500 Index: Only stocks that are part of the Nifty 500 Index at the time of review are eligible for inclusion in the Nifty 500 Momentum 50 Index.

2. F&O availability: Stocks must be available for trading in the futures & options (F&O) segment. If a stock is not available for trading in this segment, it becomes ineligible.

3. Circuit breaker instances: The stock under consideration which have hit the upper or lower circuit price band more than 20% of the total trading days in the past six months are excluded.

4. Promoter's pledged shares: Companies with more than 20% of their promoters' shares pledged are ineligible for inclusion.

5. Liquidity measures: Stocks in the bottom 10th percentile based on six-month average daily turnover are excluded. Stocks in the bottom 10th percentile based on turnover ratio are also excluded.

6. Momentum score: The index selects 50 companies based on their normalised momentum score, which is calculated using six-month and twelve-month price returns adjusted for volatility.

7. Weighting methodology: The weight of each stock in the index is determined by a combination of its normalised momentum score and free-float market capitalisation.

The index is reconstituted twice a year, in June and December. The cut-off dates for data consideration are May 31 and November 30. The index is managed by a professional team under a three-tier governance structure, including the Board of Directors of NSE Indices Limited, the Index Advisory Committee (Equity), and the Index Maintenance Sub-Committee.

Pros of investing in index funds tracking the Nifty 500 Momentum 50 Index

The Nifty 500 Momentum 50 Index is a unique investment avenue designed to capture stocks with strong momentum. By investing in this index, individuals can leverage a strategy that has demonstrated potential for significant gains under certain market conditions. Here, we'll explore the compelling advantages of considering this index for your portfolio.

Momentum investing advantage: As mentioned above, momentum investing revolves around identifying stocks that exhibit upward price trends, as past strong performance often signals continued growth in the short term. This index focuses on such high-performing stocks, offering the opportunity for substantial returns.

Simplified stock selection: Selecting individual stocks that demonstrate momentum can be complex and resource-intensive. By investing in this index (either through index funds or ETFs), investors gain access to a pre-selected basket of high-momentum stocks, eliminating the need for exhaustive research and monitoring.

Sector diversification: Although the index emphasises momentum, it spans a variety of sectors. This diversification reduces exposure to sector-specific risks while still capturing the benefits of individual stock trends.

Transparency: The Nifty 500 Momentum 50 Index is rule-based, meaning stocks are included based on clear eligibility criteria like momentum scores and liquidity. Investors can easily track the methodology and performance of the index, ensuring a transparent investment process.

Semi-annual rebalancing: The index undergoes semi-annual reconstitution, ensuring that it remains relevant and aligned with market trends. This regular update enables it to adapt to changing dynamics, retaining only those stocks that continue to exhibit strong momentum.

Lower costs: Investing in index mutual funds or ETFs tracking the Nifty 500 Momentum 50 Index is generally more cost-effective than actively managed funds. With minimal management fees, these funds offer an affordable way to participate in momentum investing

Risk-tuned weightage: The index uses a mix of normalised momentum scores and free-float market capitalisation for stock weighting. This approach balances momentum exposure with stock liquidity and market cap, mitigating the risks associated with excessive reliance on small-cap or highly volatile stocks.

Alignment with market trends: In bull markets or periods of strong growth, momentum investing often outperforms other strategies. The Nifty 500 Momentum 50 Index is well-positioned to capitalise on these favourable conditions, making it an attractive option for growth-focused investors.

Risks associated with investing in the Nifty 500 Momentum 50 Index

While investing in the Nifty 500 Momentum 50 Index can be appealing due to its growth-focused strategy, it's essential to understand the associated risks and drawbacks. Like any investment vehicle, this index has characteristics that may not align with every investor's goals or risk tolerance. Let's delve into the cons to make an informed decision.

Volatility and risk: Momentum investing relies on stocks exhibiting strong upward price trends, which can be inherently volatile. These stocks are often more sensitive to market fluctuations, leading to unpredictable short-term performance. In bear markets or downturns, momentum-based strategies may underperform as high-flying stocks tend to correct sharply.

Limited downside protection: Momentum investing focuses on upward-trending stocks, potentially ignoring those with stable prices or low volatility. This approach can leave portfolios vulnerable in turbulent markets, where defensive stocks might outperform.

Sector overexposure: The index does not actively manage sector exposure beyond diversification rules. At times, high-momentum stocks may cluster in specific sectors, increasing sector-specific risks.

Potential for herding behaviour: Stocks with high momentum scores often attract significant attention, leading to herding behaviour. This can inflate valuations, creating a bubble-like scenario that may result in sharp corrections.

Overreliance on historical trends: The concept of momentum investing is based on the assumption that past trends continue in the future. However, market conditions can shift rapidly, and stocks that performed well in the past may not necessarily sustain their momentum.

Challenging market dynamics: Momentum strategies perform best in bull markets, but their efficacy may diminish in flat or declining markets. Investors should prepare for varying outcomes based on broader market conditions.

What are the differences between the Nifty 50 and the Nifty 500 Momentum 50 Index?

1. Definition and scope

Nifty 50: The Nifty 50 is a blue-chip index comprising the top 50 companies listed on the NSE based on market capitalisation and liquidity. It represents the largest and most stable companies across various sectors, often referred to as the "elite" of the Indian corporate world.

Nifty 500 Momentum 50: Tracks the performance of 50 stocks selected from the Nifty 500 based on their momentum scores. Focuses on stocks that exhibit strong price trends over six-month and twelve-month periods, adjusted for volatility

2. Selection criteria

Nifty 50: Companies are selected based on their market capitalization and liquidity. The index includes large-cap stocks that are leaders in their respective sectors.

Nifty 500 Momentum 50: Stocks are chosen based on normalized momentum scores derived from price returns over six and twelve months. The methodology adjusts for volatility to ensure smoother price trends.

3. Investment strategy

Nifty 50: Suitable for investors seeking stability and exposure to established companies. Focuses on long-term growth and consistent dividends.

Nifty 500 Momentum 50: Ideal for investors looking to capitalise on short-term price trends and growth opportunities. Emphasises on momentum investing, which involves buying stocks with strong upward price movements.

4. Risk and volatility

Nifty 50: Being composed of large-cap stocks, the Nifty 50 is relatively less volatile and offers stability, making it suitable for conservative investors.

Nifty 500 Momentum 50: Includes stocks with high price momentum, which can be more volatile. Requires a higher risk tolerance.

5. Sector representation

Nifty 50: Covers major sectors of the economy, with a heavy concentration in financial services.

Nifty 500 Momentum 50: Diversified across sectors but focuses on stocks with strong momentum, which may lead to sector-specific overexposure.

6. Performance trends

Nifty 50: Tends to perform better during market slowdowns due to the resilience of large-cap stocks. Offers steady, long-term growth with lower short-term fluctuations.

Nifty 500 Momentum 50: Outperforms during bullish market phases due to the inclusion of high-momentum stocks. May underperform in flat or bearish markets.

Who should invest in the Nifty 500 Momentum 50 Index?

Index funds tracking the Nifty 500 Momentum 50 Index offer a distinctive investment opportunity for individuals looking to harness the power of momentum investing. However, these funds are not a one-size-fits-all solution. Understanding the ideal investor profile is crucial before committing your hard-earned money. Let’s explore who should consider adding these index funds to their portfolio.

1. Growth-oriented investors: If your primary objective is to achieve substantial capital appreciation over time, this index may align with your goals. Momentum investing targets stocks that have demonstrated strong price performance, which could lead to significant gains during bullish market phases.

2. Investors looking to diversify: The Nifty 500 Momentum 50 Index encompasses companies across various sectors and market capitalisations. Including a fund tracking this index can provide diversification to your portfolio, complementing investments in blue-chip, value, or debt instruments.

3. Passive investors: Those who prefer a hands-off approach to investing will appreciate the simplicity of index funds tracking the Nifty 500 Momentum 50 Index. These funds require minimal management and offer a straightforward way to gain exposure to momentum stocks.

4. Investors with a long-term horizon: Momentum investing may experience periods of underperformance in sideways or bearish markets. A long-term investment horizon is essential to weather short-term volatility and capitalise on the potential for growth over time.

Taxation of investment made in Nifty 500 Momentum 50 tracking Mutual Funds

Investments in index funds or ETFs tracking the Nifty 500 Momentum 50 Index are classified as equity-oriented mutual funds. This classification is important because it determines the applicable tax rates and holding period criteria.

• Capital gains from these investments are taxed based on the holding period.
• Short-term capital gains (STCG): If the units are sold within 12 months of purchase, the gains are considered short-term. STCG is taxed at a flat rate of 20%, irrespective of the investor's income tax slab.
• Long-term capital gains (LTCG): If the units are held for more than one year, the gains are classified as long-term. LTCG is taxed at 10% on gains exceeding ₹1 lakh in a financial year. Gains up to ₹1 lakh are exempt from tax.

Conclusion

The Nifty 500 Momentum 50 Index employs a rigorous selection process to ensure that only high-momentum stocks with strong fundamentals and liquidity are included. This makes it an attractive benchmark for investors and fund managers seeking to capitalize on momentum-based strategies. 

Index mutual funds tracking the Nifty 500 Momentum 50 Index present a compelling opportunity for investors seeking growth through momentum investing. While they offer potential for higher returns and diversification, it's essential to assess individual risk tolerance and investment goals before diving in. As always, consulting a financial advisor can help tailor investment strategies to your needs.

Disclaimer: Investing in mutual funds involves risks, including potential loss of principal. Please consult with a financial advisor before making any investment decisions.

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