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Want to invest in quant funds? Read this

By Sarbajeet K Sen
June 28, 2021 09:13 IST
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Quant funds have a very short track record, and have underperformed so far, reveals Sarbajeet K Sen.

Illustration: Uttam Ghosh/Rediff.com
 

Axis Mutual Fund joined a select set of fund houses -- DSP, ICICI Prudential, Tata, Nippon India and Quant -- that offer quant funds.

Since it is a new category, retail investors should educate themselves about it before investing.

How quant funds work

These funds select stocks by applying quantitative parameters or filters.

Qualitative research (interviews with promoters and people within the sector) does not play a part in stock selection.

Human discretion also does not have a role here. The fund management team prepares an algorithm that constructs the portfolio and rebalances it periodically.

No deviation from mandate

These funds do away with human bias and judgement.

They also bring a steadfast approach to stock picking.

"There is no risk of nasty surprises in the form of deviation from the mandate," says Rishi Kohli, managing director and chief investment officer-quant strategies, Avendus Capital Public Markets Alternate Strategies.

These funds have a low expense ratio. The average for regular funds in this category is 1.49 per cent compared to 2.23 per cent for large-cap funds.

Data paucity and high churn

Availability of information declines as one goes from large-cap to small-cap stocks.

Hence, most quant funds focus on large- and mid-cap stocks.

Small-cap stocks, which offer a lot of scope for alpha generation, tend to be underrepresented.

"It may not make sense to look beyond mid-caps in a quant fund due to liquidity constraint," says Kohli.

High churn is another issue. The median portfolio turnover ratio for the category was 174 per cent in April 2021, compared to 59 per cent in large-cap funds.

"While stock selection should not be a one-time exercise, one has to be careful about avoiding excessive churn," says Ashwin Patni, head, products and alternatives, Axis Mutual Fund.

Quant models rely on data, which typically becomes available with some lag.

Moreover, when the trend is about to change, say, a company's prospects are set to improve, that information is likely to be captured faster through qualitative research, which is not used by these funds.

Quant funds have a very short track record, and have underperformed so far.

Barring Nippon India's fund (launched in January 2013), the rest were launched in June 2019 or after.

Should you invest?

Investors disappointed with the performance of active funds move to passive funds, which invest in market cap weighted indices.

"Some investors may not want market cap to be the primary criterion for stock selection. They may opt for quant funds, which can be based on factors like quality, low volatility, etc," says Arun Kumar, head of research, Fundsindia.com.

Most investors should ideally wait until these funds have developed a track record of five-seven years.

Only those highly convinced about this approach should begin with a small allocation now.

Ideally, your portfolio should be diversified across five baskets--value, quality, blend (quality and value), mid and small-cap, and international.

A quant fund, depending on its style, can find a place in the appropriate basket, partly or fully replacing an active fund.

But remember that passive funds and active funds both have a considerable track record in India.

If you decide to invest in quant funds, do so for the long term, as they can underperform in the short run.

"These funds are built based on data and statistics across long periods. As more trades happen and more market cycles and phases get covered in live condition, a quant fund gets closer to its stated objective," says Kohli. Adds Patni: "Have a time frame of three-five years or more," says Patni.

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