Momentum Funds Explained: Investment Strategies & Market Trend

What Is a Momentum Fund

A momentum fund is an investment fund that focuses on buying stocks or assets that show strong earnings or price trends. These funds can offer high returns if trends continue, but also carry high risk if the market suddenly shifts. To choose investments, funds often use momentum scores or indices that rank stocks based on their recent performance. Investors should understand the fund’s strategy, including whether it is actively- or passively-managed, since this affects its risk and performance.

Understanding the Mechanics of Momentum Funds

Momentum funds can offer high returns, but they require close monitoring because their factors can change quickly. Few funds focus solely on a company's momentum, though many active strategies consider momentum factors.

How Momentum Analysis Influences Investment Decisions

Momentum factors include many different stock characteristics. Some of the most common are price movement, revenue and earnings. In the investment world, many momentum indices are widely used by momentum-focused ETFs. These ETFs generally consider the one-year trailing performance returns of stocks in a targeted momentum index. Momentum indices also give stocks a momentum score in addition to following performance returns. Momentum scores often consider characteristics like value, size, and quality. Momentum scores use fundamental analysis to give more insights beyond just performance returns. Some technical funds invest using indicators like price breakouts from historical levels.

Momentum analysis places a high emphasis on a stock’s market return. Many funds rely on past performance as the primary factor for inclusion. These funds support the idea that past performance may predict future returns. In many cases positive performance is generated by positive revenue and earnings compounding over time. Investors should be cautious as these funds often reflect market risks and returns.

Key Considerations for Investing in Momentum Funds

Momentum funds rely on many factors, so investors must understand the fund's philosophy and risks. Most funds focus primarily on a company’s past performance. This differs from growth funds that focus more on future earnings and revenue expectations than past trends.

Actively managed momentum funds will often rebalance quarterly to ensure the portfolio’s investments are based on the most current historical return evaluations. Most passive momentum indices will rebalance semi-annually. The frequent rebalancing helps to keep the strategy aligned with its focus. Thus, these funds typically have high turnover and often take advantage of short-term price movement gains.

The AQR Large Cap Momentum Style Fund is one of the most popular momentum funds offered as a mutual fund. Numerous other momentum funds also exist in ETF vehicles, such as the iShares Edge MSCI USA Momentum Factor ETF, SPDR Russell 1000 Momentum Focus ETF, Invesco S&P Emerging Markets Momentum Portfolio, USAA MSCI USA Value Momentum Blend Index ETF and the USAA MSCI International Value Momentum Blend Index ETF.

The Bottom Line

A momentum fund is an investment that focuses on companies with rising earnings or stock prices. These funds can generate high returns, but are risky because trends can change quickly. They often use past performance to predict future gains and often rebalance their portfolios. This means they buy and sell a lot of their holdings. As an investor, you can purchase momentum funds as mutual funds or ETFs.

Investopedia does not provide investment advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor, and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.