MTUM: Largest Momentum ETF, But Slow, Ineffective Strategy

Summary

  • Momentum funds invest in stocks with strong returns in the recent past, and tend to outperform.
  • MTUM is the largest momentum ETF in the market.
  • An overview of the fund and its strategy follows.
  • This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »
Accelerating to 100mph

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Author's note: This article was released to CEF/ETF Income Laboratory members on May 7th, 2022.

The iShares Edge MSCI USA Momentum Factor ETF (BATS:MTUM) is the largest momentum index ETF in the market. Momentum strategies and funds focus on stocks which have performed well in the recent past, expecting further gains. Momentum strategies tend to work, and have outperformed in the past. MTUM's specific strategy, however, does not seem to work all that well. Specifically, the fund is rebalanced semi-annually, which is simply too infrequent, and too slow, for current market conditions. The fund is consistently playing catchup with the market, and badly.

In my opinion, although there is some merit to momentum strategies, MTUM's specific strategy is simply excessively slow, and incredibly ineffective. As such, I would not be investing in the fund at the present time.

MTUM - Overview

MTUM is an equity index ETF. It is administered by BlackRock, the largest investment manager in the world. MTUM tracks the MSCI USA Momentum SR Variant Index, and index of U.S. equities with strong risk-adjusted momentum. It is a surprisingly simple index, investing in the large-cap U.S. equities with the strongest 6-month and 12-month price performance, excluding the last month, and standardizing for volatility.

Let's explain how the above works using Microsoft (MSFT), the fund's largest holding, as an example. We first gather some basic data about the stock, courtesy of Seeking Alpha/YCharts.

Microsoft Returns

Seeking Alpha - Chart by author

We then calculate the relevant metrics and scores. 6-month momentum is simply equal to 6-month price performance minus 1-month price performance. Similar process for 12-month momentum. The final momentum score is the average of the prior two metrics, divided by volatility. Results are as follows.

Microsoft Momentum

Calculations by Author

As can be seen above, Microsoft has a momentum score of 0.22. These scores are not easy to interpret, but the fact that the score is positive tells us that Microsoft has positive momentum. In my opinion, Microsoft clearly does not have positive momentum. The stock has been down for months, has significantly underperformed relative to the S&P 500 for the same, as have most tech stocks. Sentiment is also incredibly bearish, as investors fear skyrocketing inflation, rising rates, and deteriorating economic conditions. Under these conditions, I would argue that Microsoft has negative momentum. MTUM seems to have arrived at the opposite conclusion, which I think is mistaken.

In my opinion, the above is a significant negative for the fund and its shareholders. Momentum strategies mostly work, but MTUM's underlying index does not follow an adequate, effective momentum strategy, as evidenced by their Microsoft momentum score / portfolio inclusion.

Moving on, MTUM's underlying index then compares Microsoft momentum score to those of its peers, and selects for inclusion those companies with the highest scores. MTUM's number of holdings is somewhat at the discretion of its index manager, with the fund currently investing in 121 securities. It would not be viable to calculate these scores for all relevant U.S. equities, but I did manage to calculate the same for the S&P 500 itself, which might prove instructive. Results are as follows.

S&P 500 Momentum

Calculations by author

As can be seen above, the S&P 500 has a momentum score of 0.07, quite a bit lower than Microsoft, hence the company's inclusion in the fund.

MTUM's underlying index does a similar process to the one above to select relevant companies for portfolio inclusion. The fund is rebalanced semi-annually, generally in the last day of May and November. In my opinion, semi-annual rebalancing is simply too infrequent, too slow, under current market conditions. Volatility is high and cycles are getting shorter. Semi-annual rebalancing means the fund is constantly playing catchup with the market.

Microsoft is the best example of the above. Microsoft is currently MTUM's largest holding. Last rebalancing was in late November 2021. MTUM invests in companies with strong momentum, meaning past performance, meaning performance in the months prior to November 2021 in this particular case. That was indeed the case, with the company outperforming the S&P 500 in the months prior to said date, as expected.

Chart
Data by YCharts

In my opinion, the process described above is self-evidently slow and ineffective. MTUM is investing in Microsoft because it performed well during mid-2021, close to a year ago. Conditions have markedly changed since, as inflation has skyrocketed, interest rates are rising, and economic conditions are deteriorating. These were minor / non-existent issues in mid-2021, so MTUM is effectively ignoring these recent trends. Right now, momentum means energy, commodities, materials, and the like. As such, MTUM should be investing in like Exxon (XOM) or Nucor (NUE), not companies like Microsoft, which were performing well last year, but have underperformed in the recent past.

MTUM's slow, ineffective momentum strategy should be unsuccessful in delivering strong, market-beating returns for shareholders, as has generally been the case. Microsoft has underperformed since becoming MTUM's largest holding, and so has the fund, as expected.

Chart
Data by YCharts

From what I've seen, MTUM is consistently behind the curve, focusing on companies and industries with 'momentum', long after momentum has shifted, and trends have started to reverse. As an example, MTUM was focusing quite heavily on tech during late 2020, as tech had significantly outperformed during the year, as the coronavirus pandemic raged. Data below is for late 2020 / early 2021.

MTUM Sectors

MTUM Corporate Filings

By late 2020, however, the tide was starting to shift. Vaccines had been developed and announced, the economy was starting to reopen and recover, and investors were starting to shift towards hard-hit old-economy industries and companies, including financials, to the detriment of tech. Tech underperformed soon after MTUM went all-in on said industry, causing the fund to underperform relative to the S&P 500.

Chart
Data by YCharts

By mid-2021, the fund rebalanced their portfolio towards financials, which had seen particularly strong returns in the prior months (see above). Table below is for mid-2021.

MTUM Sectors

MTUM Corporate Filings

Soon after, the trend reversed, with financials underperforming, and tech outperforming. MTUM was overweight financials, and so underperformed, as expected.

Chart
Data by YCharts

By late 2021 the fund had rebalanced according to the trends above, selling some its financials to refocus on tech. Table below is for late 2021, early 2022.

MTUM Sectors

MTUM Corporate Filings

Once again, the trend soon reversed itself, with tech significantly underperforming, a drag on MTUM's performance.

Chart
Data by YCharts

MTUM's strategy has been ineffective for more than a year, leading to consistent, significant underperformance relative to the index. In my opinion, the overall situation is quite clear. Momentum works, momentum with a six-month lag does not, so MTUM's strategy will consistently lag the market, leading to underperformance. A closer look at the fund's performance might prove instructive.

MTUM Performance

Seeking Alpha - Chart by author

As can be seen above, MTUM has performed in-line with the S&P 500 for the past five years or so, almost since inception. Performance started to deteriorate around two / three years ago, especially during the past twelve months. This is because tech consistently outperformed before 2021, and so MTUM's slowness was not a significant negative. MTUM was always overweight tech, tech always outperformed, and that was that. Conditions have become much more volatile since, and the fund's slowness has taken its toll. In my opinion, volatility is here to stay, and so the fund's strategy will lead to moderate underperformance relative to the index. This has been the case these past three years and will, I believe, continue to be the case in the future.

Conclusion - Hold

MTUM is the largest momentum ETF in the market. MTUM's strategy is too slow to take advantage of volatile market conditions, leading to losses and underperformance in the past. I expect further underperformance in the future, so see no reason to invest in the fund.

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This article was written by

Juan de la Hoz profile picture
7.02K Followers
CEF/ETF income and arbitrage strategies, 8%+ portfolio yields

Juan has previously worked as a fixed income trader, financial analyst, operations analyst, and economics professor in Canada and Colombia. He has hands-on experience analyzing, trading, and negotiating fixed-income securities, including bonds, money markets, and interbank trade financing, across markets and currencies. He focuses on dividend, bond, and income funds, with a strong focus on ETFs, and enjoys researching strategies for income investors to increase their returns while lowering risk.

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I provide my work regularly to CEF/ETF Income Laboratory with articles that have an exclusivity period, this is noted in such articles. CEF/ETF Income Laboratory is a Marketplace Service provided by Stanford Chemist, right here on Seeking Alpha.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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