Investors have benefitted from the performance of a small number of stocks driving market returns but may have lost sight of the risks involved in following that trend and how concentrated it can make their portfolio, according to Fidelity International.
Fidelity Research Global Equities Fund portfolio manager Matt Jones said momentum has become a powerful force in investment performance given investors have been rewarded for owning what is already working but can mask the reasons behind that impetus.
“When something works for a long time, it can start to feel less like a risk and more like a certainty, but investors should be questioning what is driving returns beneath the surface,” Jones noted.
“When enough capital crowds into the same ideas for long enough, many roads eventually lead to the same destination. The distinction between quality, growth and momentum can begin to blur.
“Strong performance attracts investment, and that flow of investment pushes prices higher. Higher prices then attract more capital. The cycle continues until it doesn’t. None of this means momentum is inherently bad. Indeed, momentum has been one of the strongest drivers of market returns in recent years.
“For investors, it’s worth considering whether portfolios are benefiting from deliberate exposure to momentum, or whether exposure has simply accumulated over time as a by-product of portfolio construction.”
Jones added momentum driven investment can lead to portfolios becoming more concentrated without investors being aware of that fact.
“When we talk about concentration, most people immediately think about stock or sector weights, but concentration can also exist at a much deeper level,” he explained.
“For example, you could have multiple asset managers, across multiple strategies and mandates, and yet still end up heavily exposed to the same underlying factor, such as momentum.
“Investors should ask themselves: How much of a portfolio’s return profile is dependent on a narrow group of stocks, sectors or factors that continue to dominate? How diversified are the underlying alpha sources? What risks are they actually being paid for taking?
“Some investors may conclude their existing exposures remain appropriate. Others may identify areas where diversification could be improved.
“Momentum can be a powerful tailwind when it is working but the challenge is ensuring it’s not the only engine powering the portfolio,” he concluded.