Motley Fool’s Bill Mann Explains How the Momentum Factor ETF Separates Quality From Hype

The Daily Upside: Momentum usually follows performance, but performance isn’t always about fundamentals. It can be about hype and story too. How does a passive fund account for that and tell the difference?

The Motley Fool, our sister company, has always based its research on finding the highest-quality companies. So the very top of our funnel is companies they’ve identified as being the best of the best. When a lot of people think about momentum, they think of it as riding what’s hot. For us, it’s more about finding what’s performing relatively well based on other factors we’ve brought to the table, and that’s what makes our fund a little different from what else is out there.

The Daily Upside: Momentum is often thought of as a short-term signal. How does something like this fit into a long-term portfolio?

A lot of people think of momentum as basically latency, or money flows. We use a definition that’s a lookback averaging about six months, ranging from one month to two years. So you’re not trying to jump onto the hottest of the hot, which usually has more to do with money flows than the quality of the company. When you expand that definition just a little, you end up finding companies that are moving for genuinely good fundamental reasons, rather than because they were mentioned on X or on financial television at that moment.

The Daily Upside: Advisors don’t want their clients chasing performance. How do you avoid getting in at the peak, and how do you determine whether a stock still has room to run?

It’s maybe the thing that’s most fundamentally misunderstood about momentum, which is that momentum is based on relative performance. If you’ve set it up the way our factor fund is set up, you’re not going to be grabbing the hottest of the hot. So we’re not too worried about whether we’re buying something at the peak, because we have that two-year lookback. When you build in buffers like that, you don’t end up with companies that turn over super quickly. It provides a more gentle ride, and you end up with lower turnover than you might expect from a momentum fund.

The Daily Upside: Concentration has been a big issue this year, and it’s favored big tech. What other areas have potential in this kind of strategy?

In every area, the Motley Fool has identified high-quality companies. What I’d say about our sister company is that there are companies they’ve had recommendations on constantly since 2004 and 2006. A lot of the most successful companies you can think of have been in our recommendation universe for decades at this point. When that’s the top of your funnel, it lowers your capacity to end up concentrated in the hottest of the hot. MFMO also has a position size limitation of 4.8% on reconstitution, so that prevents us from being too heavily weighted in any individual company.

The Daily Upside: With the issues the tech sector has had this year, there’s been a rotation into energy and industrials. How quickly is a change like that reflected in the portfolio?

In general, we do a reconstitution every quarter. Our lookback starts at 20 market days and goes back to two years, with an average of about six months. That’s important because it prevents us from being too whipsawed by the market itself. We see plenty of opportunity, and we have plenty of exposure in some energy names within the fund, but these aren’t names that disappeared in January, reappeared in March, and disappeared again in September. MFMO has very good exposure to tech and AI, but it also has pharmaceutical exposure, banking exposure, and consumer cyclical exposure. We really do have it across the board.