How the Value & Momentum Strategy Responds to Market Shifts

The last few months have tested even the most seasoned investors. Mid- and small-cap stocks, which had been on a strong upward run, are now under pressure. Style strategies like value and momentum, preferred for risk-adjusted outperformance, have sharply reversed.

In this context, understanding how factor-based portfolios respond to changing market dynamics is more critical than ever.

The Value & Momentum smallcase by Windmill Capital applies two proven investment factors: value and momentum, to identify fundamentally strong companies that are also gaining market traction. While this approach has delivered a strong 25.2% CAGR over three years, recent months have tested its resilience amid broader factor reversals.

In this note, we break down:

How the strategy is built to capture long-term returns,
What recent sector-level trends reveal,
And why a disciplined, rules-based process still holds strong through market cycles.

The foundation

Factors are broad, persistent drivers of stock returns, and form the foundation of many modern investment strategies. For example, investors with higher risk appetites often prefer small-cap stocks, as historical data suggests they offer higher long-term returns compared to large-cap stocks. This outperformance compensates for the greater risk associated with smaller companies, which typically have less stable business models, limited customer bases, and more volatile share prices.

The Value & Momentum smallcase by Windmill Capital is a multi-factor investment model that captures two proven style factors:

Value: Stocks that are undervalued relative to their fundamentals tend to outperform pricier peers over time. These are companies trading below their intrinsic worth, offering potential for long-term price appreciation.
Momentum: Stocks that have shown recent price strength are expected to maintain that trend. The momentum factor assumes that rising stocks will continue to perform well in the near future.

This smallcase appeals to investors seeking a blend of undervalued stocks that are also gaining market traction. The Value & Momentum smallcase specifically leverages style factors—particularly value and momentum—to construct a portfolio aimed at capturing consistent, risk-adjusted returns.

While the smallcase does not impose any market capitalisation limits, its stock selection criteria naturally tilt towards small- and mid-cap stocks, as these are often undervalued and offer higher growth potential.

Under Pressure: The Impact of Value and Momentum Style Reversals

While the smallcase has delivered a compounded return of 25.2% over the past three years, it has declined by 17% since October last year.

Although the broader market downturn has weighed heavily on mid- and small-cap stocks, the situation has been further exacerbated by the recent underperformance of style factors such as value and momentum.

As the chart above shows, while the Nifty 500 has declined by around 7.4% since Oct’24, the Nifty 500 Value 50 Index (tracked by the UTI Nifty 500 Value 50 Index Fund) and the Nifty 500 Momentum 50 Index (tracked by the Nippon India Nifty 500 Momentum 50 Index Fund) have fallen more sharply—by approximately 15% and 24%, respectively. The smallcase’s 14.5% dip sits right in between the 2 styles.

Sector-Level Insights: Tracking Momentum Reversals Across the Portfolio

Let’s now review sector-level performance since the September 2024 rebalance. The table covers data from the September ’24, December ’24, and March ’25 rebalances.

Indus Towers from the Communication Services sector was the weakest performer, falling ~22% during the September ’24 rebalance. Interestingly, it had delivered a strong ~26% return in the May ’24 rebalance.

Kirloskar Oil Engines Ltd from the Industrials sector gained ~8.1% in May ’24 but declined ~20% in the following rebalance period.

Similarly, Zydus Lifesciences, which rose 11.1% during the May ’24 rebalance, erased those gains with a 12.5% drop in the subsequent period.

This shows a common challenge with momentum investing, particularly in falling or volatile markets— the sharp reversal in stock performance. Stocks that had previously shown strong upward trends often correct more sharply when the broader market declines.

Another healthcare company, Aurobindo Pharma Ltd, declined by 19% during the September ’24 period and was dropped subsequently.

In the Industrials sector, Apar Industries and KNR Constructions—both part of the December ’24 rebalance—saw sharp losses of 34% to 43% within just three months and were dropped.

Similarly, three Material sector stocks—Castrol India Ltd, National Aluminium Co Ltd, and Welspun Corp Ltd—selected during the September and December ’24 rebalances, fell between 11% and 28% over a single rebalance cycle.

These examples also demonstrate the model’s effectiveness in spotting weakening momentum. By combining a quarterly rebalancing schedule with a momentum filter, the model quickly identifies and removes underperforming stocks as trend strength fades.

In conclusion

While recent underperformance reflects broader market weakness and temporary headwinds for style factors like value and momentum, the Value & Momentum smallcase remains grounded in time-tested principles. The portfolio’s construction ensures that stocks failing to maintain momentum or valuation discipline are quickly filtered out, limiting prolonged downside exposure. This disciplined, factor-driven approach helps maintain portfolio quality through cycles, positioning it to rebound strongly when market conditions turn favourable.

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