Benchmarks globally have seen a fair amount of volatility recently. With impending UK and Spanish elections, cash-strapped Greece being given a reform deadline, an economic slowdown in China and markets anticipating the Fed’s rate hike, many investors are 
feeling more bearish.
At the end of last month, a global sell-off of stocks and a pickup in volatility occurred, affecting numerous indices from all over the world. Despite this being far from ideal, BlackRock’s Russ Koesterich (pictured) says that it offered a prime demonstration of how unsafe some areas of the market are.
“The recent sell-off and pickup in volatility serve as a useful reminder of the risks lurking in some areas of the market,” he said. “This was particularly true among the so-called momentum stocks – as well as some that have been acting that way.”
Momentum investing can be a high-risk game, which involves selling down “cold” stocks and riding “hot” ones whenever they are in trend.
Certain stocks that fall under this category are becoming increasingly popular. In light of this, FE Trustnet explores the momentum trades which could be placing your portfolio at risk.
Biotech
Biotech stocks have performed strongly over the last few years. The Nasdaq OMX Biotechnology Index has risen more than 300 per cent in sterling terms over the past five year, far outpacing the gains seen in UK and global equities.
Performance of indices over 5yrs
Source: FE Analytics
However, its maximum drawdown – which shows the loss an investor would have if they bought and sold at the worst times – over this time was 14.59 per cent, which is higher than the FTSE All Share and MSCI World Index.
Darius McDermott, managing director at Chelsea Financial Services, warns that while past performance cannot be relied as an accurate prediction for future performance, some eye-watering corrections have occurred within the sector in the past, which can be seen in the above graph.
“Biotech stocks have in the past enjoyed successive periods of stellar gains only to be clipped back significantly,” he said. “It is important to understand that every so often, momentum reverses. While momentum investing works best in a bull market, there always lies danger when riding the crest of a wave.”
Last year is a prime example of when biotech stocks have lost their footing. Between the end of February and mid-April, the Nasdaq OMX Biotechnology index dropped more than 20 per cent after concern spread that the stocks could have entered bubble territory.
Equity income
Most investors have a place for equity income within their portfolios, as they want exposure to the compounding power of dividends over time and the persistent demand from income created by an ageing population.
Recent years have seen this demand intensify, not least due to the quantitative easing programmes launched by the world’s central banks. This pushed down yields on bonds and forced investors into equities, with so-called bond proxies being one of the first areas they chose to park their money.
Koesterich said: “Yield plays were some of the best-performing stocks last year.”
“While investors don’t typically think of these as ‘momentum’ names, their relative valuations are stretched and, like biotech, they have benefited from a steady stream of money into the space. These stocks – utilities, for example – warrant caution as well.”
Taking his example of utilities, FE Analytics shows the FTSE All Share Utilities Index has made returns of 82.11 per cent over the past five years, which is 28.66 percentage points more than the FTSE All Share Index and 12.76 percentage points more than the MSCI World Index.
Performance of indices over 5yrs
Source: FE Analytics
However, UK utilities at least have had a tough year, making less than a third of the returns of the MSCI World. This is not doubt down to jitters caused by Ed Miliband’s pledge to implement price freezes in the sector in the event of a Labour victory.
Nonetheless, the strong gains of income-paying sectors such as utilities and healthcare could come under further pressure if improved investor sentiment leads managers to pay more attention to growth sectors, especially those that have lagged in recent rallies.
Property
The sector has become incredibly popular recently, with the average IA Property fund achieving gains of more than 13 per cent in 2014 after investors sought out areas of diversification and income for their portfolios.
Figures released last month by the Investment Association found that property funds were the best-selling sector in February, boasting net retail sales of £304m. The report also found that property has been the second-best selling sector almost every month of last year.
Performance of indices over 10yrs
Source: FE Analytics
Rathbone’s Mona Shah, however, is approaching the sector with caution.
"Many listed property vehicles are on significant premiums,” she explained. “There is a risk that investors are overpaying for exposure to this sector, given the inherent interest rate risk, but also that they are chasing further capital growth.”
“We are sceptical of the latter in the medium term. We hold vehicles with very conservative levels of gearing, no more than 35 per cent, and a bias towards quality assets. This is because we are concerned that too much money is flowing into too few assets, such that the yields on lower quality properties do not reflect these inherent risks."
Property has certainly shown itself capable of burning investors when a good run comes to a sudden end – during the financial crisis, the average property fund lost close to 50 per cent after investors fled the sector in droves.
How to avoid momentum trades
In terms of avoiding what Koesterich refers to as “momentum stocks in sheep’s clothing”, Richard Hunter, head of equities at Hargreaves Lansdown, said: “It’s down to due diligence, which is what you should be doing with any investments.”
“Make sure that the company’s cash generative, that their dividend, assuming they’re paying one, is well-covered, find out what the stock’s strength is in the market place in which it operates, what its prospects are.”
“If you start ticking those boxes, then you don’t need to get too tied up in momentum or contrarian investing, because if you tick all those boxes you’ve very possibly found a quality company.”