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All you want to know about...Quant funds

Parvatha Vardhini C | Updated on May 27, 2019 Published on May 27, 2019

Automation is taking over many highly paid jobs around the world and money management may be no exception. One illustration of this phenomenon is quant funds. In India, DSP Mutual Fund currently has a quant fund open for subscription until June 3.

What is it?

A quant fund is one in which the investment decision or the stock selection is done according to predetermined rules based on a statistical or mathematical model. Unlike active funds where a fund manager chooses his investments and the timing of entry and exit, quant funds rely on an automated program to make these decisions.

But a quant fund manager may not be entirely hands off like an index fund manager. He often designs and monitors the model that throws up the portfolio choices.

DSP’s quant fund is not the first to be launched in India. Reliance Quant fund has been in the market for many years now. Apart from mutual funds, hedge fund managers also use quantitative models.

Why is it important?

The most important advantage of using a pre-programmed model to select stocks is that it eliminates the human bias and subjectivity that often trip human investors. For instance, among other conditions, the model that DSP Quant Fund follows chooses stocks based on high return on equity and earnings growth consistency and potential. It will eliminate highly leveraged and volatile companies. Using a model also allows consistency in strategy across market conditions.

Often, in bearish or volatile markets, active fund managers are forced or tempted to cut positions in certain stocks or shift their investment styles.

Since a quant fund follows a somewhat passive strategy, expenses are lower here than active funds. Reliance Quant fund (regular plan), for example, has an expense ratio of 0.98 per cent, which is lower than the 2-2.9 per cent the fund house charges on its other equity funds. Quant funds can also have built in checks on sector and stock concentration, something which passive funds that mirror the index do not do.

Why should I care?

The big pluses of quant funds are that you don’t have to worry about the manager quitting, making mistakes or going off the rails on the fund mandate. But elimination of human bias doesn’t automatically guarantee that the fund will be a top performer.

Quant funds use models that are tested based on historical data and the past is not always a good indicator of the future. Benchmark-beating returns or higher returns than active funds are not a given. This apart, if the holdings are rebalanced often, higher churn may push up costs and thereby eat into returns.

Quant funds may be more suited for long-term investors as it may take time for the strategy to play out in full. Hence investors who want to ride on momentum or book profits regularly may need to keep away from it. Finally, though this category is still nascent in India, the track record of existing funds hasn’t been great. Reliance Quant fund, for instance, has logged only 8 per cent return over the last five years and about 10.8 per cent over the last ten years — lower than the average returns of large-cap funds in this period. It has also underperformed the benchmark — the BSE 200 TRI — over short and long time-frames.

Each quant fund however may need to be judged on the workability of its own model.

The bottomline

There’s no easy way to earn high stock market returns, whether you are a human or an automated program.

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Published on May 27, 2019
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