How Nvidia’s Rise Changed The Biggest ETF Momentum

June 3, 2023

minute read

The rapid rise of artificial intelligence (AI) and the subsequent surge in stock prices, particularly for Nvidia and other tech companies, has created a challenge for a major momentum fund that is now playing catch-up. The iShares MSCI USA Momentum ETF (MTUM), the largest momentum ETF, recently rebalanced its portfolio in late May, making Nvidia its largest holding at approximately 6.3%.

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However, the fund's semi-annual rebalancing schedule means that it has entered the AI stock market relatively late. According to data, MTUM did not even include Nvidia in its portfolio before May, instead favoring energy stocks such as ExxonMobil and Chevron, which have underperformed this year.

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With approximately $9 billion in assets, the fund has experienced a 5.7% loss on a total return basis in 2023. "Momentum is very time sensitive," explained Todd Sohn, an ETF strategist at Strategas, highlighting the risks associated with buying stocks that have already experienced significant gains.

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The MSCI USA Momentum Index, which the MTUM fund follows, aims to capture the performance of hot stocks and predicts that their rally will continue in the following months. The index utilizes a combination of six- and 12-month price momentum metrics to assign a momentum score to stocks. The MSCI USA Momentum Index is rebalanced every six months, with the most recent update taking effect on June 1. The MTUM fund tracks a slightly modified version of the index, rebalancing its holdings over several days prior to the effective date.

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Researchers from MSCI noted that this rebalancing saw a higher-than-average turnover of 67%. Nvidia, Meta Platforms, and Microsoft were added to the index with a 5% weight, the maximum allowed by the methodology. The index aims to rotate out of securities that have recently underperformed and into those with recent outperformance.

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There are other momentum funds with different rebalancing methodologies that occur more frequently, such as the Invesco DWA Momentum ETF (PDP) and the Alpha Architect U.S. Quantitative Momentum ETF (QMOM). While these funds have outperformed MTUM this year, they still trail behind the S&P 500.

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Given the ongoing efforts to recover from a bear market, this may not be the ideal environment for momentum strategies, according to Todd Sohn. He explained that momentum tends to work best during strong bull markets when stocks are being bought fervently. However, the current market conditions present a more challenging scenario.

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