We must have come across words such as quants, quantitative investing etc. Though these terms are very seldom used in India and common only to developed markets such as the USA, many fund managers in our country believe that soon it will be the future of the Indian mutual fund industry.

Recently, ICICI Prudential Mutual Fund and DSP Mutual Fund filed draft offered documents for their quant-based funds with SEBI (Securities and Exchange Board of India).

You might be thinking what exactly these funds are and how fund managers are so upbeat on these funds.

In this article, we will see what exactly are quant based mutual funds

But let us first understand what these funds actually mean.

What are Quant Funds?

Quant funds make use of computer-based and mathematical quantitative models to invest in stocks. The human intervention is very limited.

Fund managers only review and reshuffle the portfolio timely. There is a proper data-driven approach that is followed under such a style of investment.

Mostly, fund houses have their own proprietary model based on which stocks are selected. These models might include parameters such as P/E, P/BV, earnings, growth, financial ratios (fundamental analysis), performance of the stock as compared to the industry.

Therefore, it involves extensive data crunching. The method eliminates the fund manager’s authority to choose a stock. The system picks the stock only if it fits the criteria fed into the fund’s model.

What is fundamental analysis of a stock? Here’s how to use it

The style or approach followed in such a method of investing is termed as “factors”. The main objective of the fund is to beat their respective benchmarks by investing in a concentrated portfolio of securities.

Types Of Quant Funds

  • Black Box

In such kind of funds, disclosure is not provided for the method and logic of investment to investors. Past performance is the only barometer for judging the particular fund.

  • Indexation

The portfolio in such kind of investment is churned less frequently. This method is passive in nature. The investment mandate is based on pre-defined rules which are known to investors.

  • Factor Models

Contrary to index funds, these funds are managed actively. The investment methodology is based on factors which could drive stock performance.

Are Quant Based Funds the Future of the MF Industry?

Many mutual fund advisors and financial planners believe that quant-based mutual funds will be able to gain more say in the industry when it becomes difficult for actively managed mutual fund managers to beat their benchmark indices.

This is because of various measures taken up by SEBI in the recent past such as TRI (Total Return Index) and other changes.

(Note: Before February 2018, all benchmark indices for mutual funds in India were exclusive of dividends. Typically, the dividend is around 1%-1.5% annually. Since the indices were exclusive of dividends, the real returns were not reflected. However, now the TRI includes the dividends by the indices thereby giving a more accurate return)

In an industry which is rapidly developing and adopting methodologies from developed markets, time is not far away when these funds also have a significant mark in the Indian mutual fund industry.

International quant funds have given handsome returns and AI is already started impacting our markets.

Example of Quant Based Fund

Reliance Quant Fund is a fund that totally runs on a qquant-based approach (It was launched in 2008);

Quant Mutual Fund makes extensive use of AI for stock selection in the portfolio. However, there is some bit of intervention from the fund management team

In a recent interview with Ashutosh Bhargava, fund manager at Reliance Mutual Fund, he explained the process of how Reliance Quant Fund actually works.

He highlighted that the fund totally eliminates any human biases. The parameters that are looked at before investing include earnings growth, valuation and price momentum.

reliance quant fund
Fund Name 1Y 3Y 5Y Expense Ratio Turnover Ratio Category Risk
Reliance Quant Fund - Direct - Growth 2.96% 12.8% 10.65% 0.19% 122% Equity
(Sectoral/Thematic)
High

The process of selection of stocks (30 stocks selected from BSE 200 Index) is repeated every 45 days. Therefore, it is totally an objective based model.

Quant Based Funds are Better than Index Funds and ETF?

Quant based mutual funds have an edge over both index funds and ETFs (Exchange traded funds).

This is because unlike both index and ETFs, quant based funds don’t just copy all the stocks in the index. But they have an investment philosophy of their own based on which stocks get selected.

This investment strategy helps these funds to beat the category of index and ETFs. At the same time, quant based funds are actively managed and also are of low costs as index funds.

Though the picture seems brighter for quant based funds in theory, but in practical terms, they have performed poorly as compared to the benchmark. Let us look at the returns of these funds in contrast to the category benchmark.

Particular 3-Year Returns 5-Year Returns
Reliance Quant Fund 11.43% 11.03%
Benchmark 14.32% 15.11%

In terms of expense ratio, a regular actively managed mutual fund usually charges 2 percent whereas Reliance Quant Fund charges 0.98 percent.

Is Quant Based Approach of Investing Practical?

best focused funds 2019

There are different schools of thought when it comes to quant based method of investing. Some believe it can be revolutionary in the coming years, whereas, others are pessimistic about the use of this method in some areas.

For example in some junctures use of human mind and experience is necessary rather than just being dependent on data analysis and numbers.

Say an institutional investor is thinking of putting a hefty amount in a mid-cap or a small-cap stock. It is not just numbers that the fund manager will look at but an important element is interaction with the management of the company to know about future plans and other aspects.

Therefore, it is a combination of both qualitative and quantitative approach. But when it comes to quant based method of investing, it is only based on the quantitative approach.

There is no attempt to understand the nature of the business and the company. There is also no interaction from the management.

Another key element to be looked at here is that quant based method of investing seems right for large caps rather than small or mid-caps.

This is because in case of the latter, there is a lot of ambiguity. If we look at global examples as well, quant based approach has been successful more in large caps rather than mid and small caps.

5 Hacks to Design a Well Diversified Mutual Fund Portfolio

Conclusion

In India, we invest in schemes and funds based on past returns and fund manager’s pedigree.

Therefore, this method and type of investment has not picked up ground as other funds.

However, a major differentiator, as well as key element missing in the Indian market, is style diversification. Hence, this sort of investment can prove to be an amicable choice for an investor.

Disclaimer: The views expressed in this post are that of the author an not those of Groww