Quant-Momentum ETF Is Getting Crushed Even as Stocks Shoot Up

The largest exchange-traded fund focused on high-flying stocks has been losing its edge.

(Bloomberg) — The largest exchange-traded fund focused on high-flying stocks has been losing its edge.

The $9 billion iShares MSCI USA Momentum Factor ETF (ticker MTUM) is trailing the S&P 500 by the most ever on an annual basis, according to data compiled by Bloomberg. The fund, which seeks exposure to shares exhibiting higher-price trends and at its height commanded more than $18 billion in assets, hasn’t seen a full week of inflows since January. After a $2.9 billion exodus, it’s on pace for the worst year of outflows since its 2013 inception. 

While MTUM has a sizable portion in tech stocks, it only added Nvidia Corp. in May, data compiled by Bloomberg show. That means the fund has missed out on a lot of the artificial-intelligence rally this year. The ETF is also heavily skewed toward one of 2023’s worst-performing sectors: health care. Meantime, its exposure to energy — a sector that’s rising again — has been cut to 5% from 25% at the start of the year. 

It’s the latest case of a capricious stock market delivering a crushing blow to momentum-chasing investors — with ill-timed rebalancing schedules at a time when former losers like megacaps rebound.

“This is the tricky portion with factor ETFs — timing when one works and when another falls out of favor is very challenging,” said Todd Sohn, ETF strategist at Strategas. “With MTUM, their semi-annual balance methodology has missed the bulk of most sector moves, particularly in what feels like an equity market that sees major moves occur within shorter and shorter time frames.”

MTUM usually rebalances in May and November. Nvidia is its top holding, followed by companies including Meta Platforms Inc., Microsoft Corp., Eli Lilly & Co. and Exxon Mobil Corp., data compiled by Bloomberg show. 

Tech stocks have ripped higher this year, buoyed partly by optimism over the promises of AI. Nvidia, which has more than tripled in the span, had already clocked a big portion of that gain before being added to MTUM. 

Factor investing selects companies not by industry, but by specific traits like how fast their prices are moving. MTUM has lost 0.5% this year, compared with a 16% advance in the S&P 500.

The momentum factor has made little progress over the past year, and certain trends don’t bode well for future returns, according to Christopher Cain, quantitative equity strategist at Bloomberg Intelligence. 

Cain looked at the Russell 1000. The dispersion of individual stock returns within the index is elevated, and a large range of returns suggest internal market rotation. That could “adversely affect momentum strategies” because the factor — at its core — relies on the premise that current trends will be extended, Cain noted.

A similar situation happened a few years ago. Stock dispersion was elevated in 2016, and the long/short momentum factor struggled during that stretch, Cain wrote in a note. When it settled down the following year, the momentum factor rose. 

Sylvia Jablonski, co-founder and chief investment officer at Defiance ETFs, says that MTUM’s semi-annual rebalances worked out great in the years before the pandemic. But post-Covid, more frequent rebalances may have led to better returns given uncertainty of recession and a very reactive market. 

“The thesis of ‘what goes high will continue to go higher’ does often work out to some degree — but when you get a pullback, decay tends to be unfavorable for this factor,” she said. “That being said, if we have a nice stock rally post August into year-end, this ETF just may regather the wind in its sails.”

–With assistance from Athanasios Psarofagis.

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