What Are Quant Based Mutual Funds? Should You Invest in Them?
Active investing has hugely dominated the Indian market for the past decade, where the primary skill of a fund manager is to identify well-performing stocks. However, quant mutual funds have been experiencing increased adoption in the country for the past few years.
What are they? Are they actually a good investment? Read on to find out.
About Quant Funds
Quant based funds are a part active, part passive investment, where the fund manager is actively involved in the investment decisions. However, their actions are determined by particular rules and restrictions that guide the final decision.
These rules and restrictions are similar to an algorithm or Artificial Intelligence (AI). They are extremely objective, leaving no room for judgements. The fund manager invests in financial securities depending upon the numerical data accumulated through quantitative analysis and research.
Since quant mutual funds are managed in a passive manner, such schemes have a lower expense ratio compared to regular actively managed funds.
The Mechanism behind Quant Funds
As mentioned earlier, quant-based mutual funds follow certain rules and regulations. Such funds utilise various machine learning tools and advanced financial models, AI, big data, and much more. These tools help in forecasting future share prices and investing accordingly.
But, who sets the rules?
The fund managers set the rules after a keen observation on significant technical and fundamental analysis. After setting these rules, fund managers do not have much involvement, as they keep on updating on their own.
However, fund managers have to monitor the funds and make minor changes if necessary. Essentially, these models utilise variables and past data, including trading volume, value, yield, beta, volatility, momentum, liquidity, correlation, alpha, and other multi-pattern models to determine a pattern that can predict future prices.
The Process of Quantitative Investment
The quantitative investment process consists of three stages, namely —
- Input system
In this stage, all essential inputs are given. These may include rules, market and company data. During this stage, stocks that feature undesirable features, such as extreme volatility, inefficient allocation of capital or other factors, are removed from the model.
- Forecasting engine
In this stage, all estimations regarding price, returns, risk parameters and other factors are determined. The stock’s evaluation is also done during the forecasting stage.
- Construction of portfolio
The construction of the portfolio happens during this stage. The quant model customises an optimum portfolio. Based on this model, fund managers assign weightage for each stock to get the needed result and reduce risks.
Benefits of Quant Funds
Quant mutual funds feature a host of benefits, including these:
- They eliminate human intervention and provide a neutral view
- They feature lower management fees because of their consistent and passive strategy. This makes them a cost-effective option.
- There is greater risk control due to a congruous investment model irrespective of dynamic market conditions.
- Computer-based algorithm ensures a fast decision-making process. This helps in quick order placements.
- Lower chances of errors than traditional investing
- Quant based funds use a superior algorithm to achieve alpha and exploit inefficiencies in the market.
- Machine learning in this model enables the analysis of substantial real-time data.
Disadvantages of Quant Funds
Along with its benefits, there are a handful of disadvantages that quant funds have. Find them below:
- These models require continuous testing to ensure they work in optimal conditions.
- Some models do not consider unexpected circumstances, which can deliver disagreeable results.
- Artificial Intelligence may result in different quant models making the same set of decisions, which can result in financial market issues.
- The model includes too many assumptions. These assumptions may not work if the market conditions change suddenly.
Final Word
Whether or not quant mutual funds are a good investment depends on investors. Preferences may vary from individual to individual. The fact is that every fund is a worthy investment if it matches investors’ financial goals. However, before moving forward, one must conduct proper market research and then delve into conclusions.