I think you are looking at it the wrong way. Let me explain why momentum works rather than investing in a small-cap or a micro-cap index, etc. Please remember that this is my understanding of why momentum works, and I can be very wrong as well, so take it with a grain of salt.
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In a bull market, an all-cap universe momentum strategy will match or underperform the small-cap or microcap index. It’s virtually impossible to beat the index in a bull market. Even if you beat it with the momentum strategy, it would be by a small margin
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When the tide turns, and we go into a bear, or a sideways market, the small-cap and/or microcap indices will go into a huge drawdown. Momentum portfolios will shift to either mid-caps or large-caps, depending on where the best performance is. So you will lose less than the other small/micro-cap indices might have lost.
Momentum works because it switches you into performing sectors and marketcaps. It does it for you because it only sees the price. This doesn’t mean that it won’t give you drawdowns. You will get hit by the initial fall, but eventually, your system will shift and give you better performance than the index. Please read the words carefully – better performance than the index, which means if the index is still falling, say 20-30% more, you may fall only 15%
Over multiple bull and bear cycles, momentum is highly likely to outperform most of the indices. Again, consider this a high probability and not an assured thing. Further, if the country itself goes into a sideways market like what China or Hong Kong did over the past decade or so, then don’t expect momentum to give super returns as well. It might give a little bit of alpha above index returns, for sure, but don’t expect it to make a ton of money in prolonged bear or sideways markets.
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