How Tech Stocks Affect Momentum ETFs

The iShares MSCI USA Momentum Factor ETF (Cboe: MTUM), one of the largest exchange traded funds dedicated to the momentum factor, and other momentum ETFs are often heavily allocated to technology stocks.

At issue for investors is when funds like MTUM increase or decrease exposure to the technology sector. The momentum factor was beloved for much of this bull market. Then, the late 2018 market slump, led mostly by stocks with the momentum designation, plagued the momentum factor, but some exchange traded funds with exposure to this factor could be worth revisiting.

Currently, the $9.1 billion MTUM devotes over 39% of its weight to technology stocks, more than triple its second-largest sector weight.

“During its latest rebalancing on May 23, the iShares Momentum fund, which picks the rapidly rising stocks based on their 6-month and 12-month performance, more than doubled its share of assets held in the technology sector to almost 40%, nearly twice as much as the Russell 3000’s 21%,” reports Evie Liu for Barron’s.

How Momentum Works

Momentum investing can target those companies that are exhibiting high levels of growth. The momentum factor selects company stocks that have recently outperformed based on the idea that “the trend is your friend” and that stock market leaders typically continue to outperform. This type of strategy can be an effective way for targeting growth-oriented companies since stocks with positive momentum often continue to generate strong earnings.

“In May, U.S. stocks in the tech industry plunged 9.6% from their latest record high, a much deeper loss than the Russell 3000’s 6.7% decline. With its heavy exposure to tech, the iShares Momentum fund may face higher risks and bigger price swings in the second half of the year,” according to Barron’s.

While momentum strategies are sector agnostic, these funds are often light on defensive sectors, groups that could be advantageous to investors in the current market environment. For example, the healthcare, consumer staples and utilities sectors combine roughly just a quarter of MTUM’s roster.

“The dramatic change in sector weightings reflects one problem of so-called factor ETFs, which systematically select stocks based on specific characteristics,” reports Barron’s. “Their holdings are rebalanced on a fixed schedule—either twice or four times a year—and the changes don’t always keep pace with rapidly changing market dynamics.”

For more information on alternative index-based strategies, visit our Smart Beta Channel.

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