Momentum investing is often viewed as a large-cap-only concept. Conversations about its applications via ETFs often lead to products such as the Invesco S&P 500 Momentum ETF (SPMO ).
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There’s nothing wrong with that. SPMO is effective at doing its job and delivering impressive returns when the momentum factor is in style. But at a time when small-cap stocks are proving quite stylish in their own rights, investors may want to consider the union of smaller stocks and momentum — a task made easy with the Invesco S&P SmallCap Momentum ETF (XSMO ).
XSMO, SPMO’s small-cap cousin, tracks the S&P SmallCap 600® Momentum Index. That gauge posted a double-digit gain in April. As is the case with the other S&P momentum indexes, SPMO’s index is home to stocks displaying high momentum scores. The $2.77 billion ETF is home to 114 stocks, indicating the index is somewhat selective in its inclusion process.
Examining XSMO’s Methodology
Speaking of inclusion, advisors and investors should take the time to understand how the XSMO basket is built.
“The S&P Momentum Indices typically utilize 12-month risk-adjusted price momentum to select stocks ranked in the top quintile of their eligible universes,” noted S&P Dow Jones Indices. “To account for short-term reversal effects, the most recent month is excluded when calculating price momentum.”
Put simply, XSMO’s index relies on risk-adjusted momentum, not a raw variant. That can create a better approach to this factor, because it can limit some of the downside when momentum wanes. XSMO holdings are weighted by a combination of floating market capitalization and momentum scores.
“This approach effectively balances market weight with targeted factor exposure. The indices are rebalanced semiannually, with a 20% buffer rule to help reduce turnover,” added S&P.
As a result, XSMO allocates no more than 3.90% of its weight to any individual holding. Momentum strategies are typically sector agnostic and that’s true of XSMO. That said, the ETF has to go where the momentum is. In this case, that results in a nearly 42% allocation to industrial and tech stocks, and another 27% of the portfolio directed to financial services and healthcare names.
XSMO may also be appropriate for long-term investors; over the trailing year, three, five and 10 years, its index beat the S&P SmallCap 600 Index.
“Furthermore, these indices (the S&P momentum gauges) have shown favorable capture ratios, delivering higher or similar gains during up markets and experiencing smaller declines during down markets,” concluded the index provider.
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