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June 24, 2022

Momentum Investing: Go With The Flow

Ask a group of people what’s the best way to invest, and you’ll get a range of answers. One proven approach that remains widely popular is factor-based investing. This approach combines characteristics of active and passive investing, and aims to enhance returns or manage risk by focusing on a particular investment factor.

There are six major investment factors:

  1. Dividend yield. Looks for excess returns from stocks whose dividend yields are above average
  2. Low volatility. Targets securities with stable earnings and lower risk than the broader market
  3. Quality. Focuses on stable profits and cash flow, reasonable leverage or better relative credit quality
  4. Momentum. Seeks companies with improving fundamentals and a recent trend of outperformance
  5. Value. Identifies lower-cost securities that are undervalued in relation to their intrinsic value
  6. Size. Targets excess returns of smaller companies relative to ones with a larger market capitalization

The Momentum factor

While each factor may be viable as part of an investment strategy – the prevailing market or economic conditions will dictate which factors are most suitable at the time – let’s focus on Momentum. It has been one of the best performing factors since the global financial crisis of 2008-09 and can work with different asset classes (stocks, bonds, commodities, etc.). The Momentum factor is among the most popular factor-based strategies.

Momentum investing turns the adage of “buy low, sell high” on its head and may actually be characterized as buying high and selling even higher. It’s a systematic process based on the belief that investors should heed – and profit from – the power of trends.

Here’s the premise of momentum investing.

Certain securities that have recently performed well should continue doing so, while underperformers may continue to lag. Many investors submit to “herd mentality” and follow the safety of the crowd (i.e., consensus thinking). As such, they often keep bidding a security higher, even if fundamentals suggest such optimism is unwarranted. This “FOMO” phenomenon may present an attractive opportunity for momentum investing to shine.

While some investors are often quick to take profits once their securities have generated gains, momentum investing stays in the game and looks to achieve even bigger wins as positive market sentiment picks up steam. The challenge is figuring out when one trend is ending and another is poised to begin.

Our Momentum ETFs

Fortunately, individual investors can avoid the guesswork and the time, effort and stress that accompany it. Our well-established suite of Momentum ETFs offer investors a disciplined, rules-based way to participate in the growth potential of upward-trending companies with share prices that have recently performed well. The three ETFs in our suite are:

  • CI Morningstar Canada Momentum Index ETF (ticker symbol WXM)
  • CI Morningstar US Momentum Index ETF (ticker YXM for CAD-Hedged; YXM.B for Unhedged)
  • CI Morningstar International Momentum Index ETF (ticker ZXM for CAD-Hedged; ZXM.B for Unhedged)

Our Momentum ETFs seek to capitalize on the Momentum factor by replicating, to the extent possible, the Morningstar® Target Momentum Indices. These proprietary indices methodically rank stocks based on above-average returns on equity, with an emphasis on upward earnings estimate revisions and technical price momentum indicators. Index constituents are equally weighted and the indices automatically rebalance quarterly, providing targeted exposure to the Momentum factor.

Using data from Morningstar Direct, here’s an example of how well the Momentum factor has performed over the past two decades. As a broad-based index of 500 large U.S. companies, the S&P 500 Index is often used to represent U.S. stocks in general. From January 1, 2002 to February 28, 2022, this index returned 9.0% on an annual basis. Meanwhile, the corresponding Momentum factor returned 11.8% annually over the same period, almost one-third higher than the benchmark index.

Should the trend be your friend?

Momentum investing seeks to take advantage of “groupthink” as investors extend the price-movement trend (higher or lower) of securities beyond what the fundamentals may indicate. On a relative basis, this investment strategy has performed well over the past 20+ years, making our Momentum ETFs worthy of consideration for diversified investment portfolios.



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