Should you invest in algorithm-based quant mutual funds?

Quant funds work on a data-driven model that relies on a mix of parameters and algorithms to identify the right stocks at the right time. But can they beat actively managed schemes?

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In a sense, a quant fund lies at the intersection of actively-managed equity funds and passively managed index funds.
Many equity fund managers have found it difficult to beat the market in recent years. In such a scenario, is an analytics-driven programme to handle a mutual fund portfolio the answer? This is the premise behind quant funds that adopt a rules-based, data-driven approach to build a portfolio of stocks. Fund houses seem keen to launch quant funds now. DSP Quant Fund has already launched its NFO and another from ICICI Prudential AMC is in the pipeline.

All in the numbers
Quant funds work on a mathematical model that relies on a mix of quantifiable parameters to identify the right stocks at the right time. It aims to remove the element of fund manager bias from the process. Essentially, it is an AI-driven approach to fund management. Each quant fund follows its own set of rules to identify stocks. Reliance Quant Fund—the only existing pure quant-based equity fund—selects stocks on the basis of parameters like valuation, earnings, price, momentum and quality. The new offering from DSP Mutual Fund will filter and select stocks using metrics across value, growth and quality. Quant AMC also offers a basket of quant-based mutual funds, but with some fund manager intervention.

Since a quant-based fund works entirely on the output thrown up by the model, its success rides on the nuts and bolts it is made of. The predefined rules must be robust enough to deliver results over time. Fund houses launching quant funds often claim superiority of their model by showing results of back-testing—where the same rules are applied to historical data to see how the model would have performed. If the fund is seen outperforming the chosen index over a long period of time, the model is considered robust enough.

Performance of quant funds has been mixed
There is no firm evidence to show that these funds can reliably outperform over time.
Return (%)
1 year 3 year 5 year
Fund name Scheme Benchmark Scheme Benchmark Scheme Benchmark
Reliance Quant Fund 3.61 9.55 11.32 14.69 8.14 12.36
Quant Tax Plan 9.61 13.12 13.44 15.52 18.62 12.24
Quant Active 7.95 7.44 13.29 14.48 15.87 12.3
Quant Absolute 11.99 13.04 10.1 13.63 12.73 11
Source: Value Research. Data as on 27 May. Quant AMC funds are not entirely quant-based. Reliance Quant Fund is the only pure quant-based fund in India.

However, critics say back-testing has its limitations. While the model may have worked in the past, there is no certainty it will continue to deliver in future. For instance, a model tilted towards earnings growth and price momentum may have worked wonders in the past 5-7 years. But the same factors may not throw up winners in the coming years. Amol Joshi, Founder, PlanRupee Investment Services, asserts, “A strong model is one that can continuously adapt and reflect evolving market realities.” Besides, some point out that such models are conveniently built to suit past data. Hindsight bias may come into play when selecting the parameters that will form the basis of the model. “Back-testing results should be taken with a pinch of salt,” argues Kaustubh Belapurkar, Director – Fund Research, Morningstar Investment Advisor India.

Limited evidence
There is no firm evidence to show these funds can reliably outperform over time. Reliance Quant Fund has woefully underperformed its benchmark over the past 3 and 5 years. It is too early to judge performance of Quant AMC’s funds, but the initial signs are encouraging. On the back of its recent showing, Quant Tax Plan has emerged the chart topper in its category for the five-year period ended 24 May 2019. This is a remarkable turnaround for a scheme that, owing to its troubled past under a previous ownership, sits at the bottom of the 10-year returns chart. Both Quant Absolute and Quant Infrastructure Fund have been second best in their categories over the past one year. However, these are not entirely quant-based funds.

Quant funds are popular abroad, but remain unknown in India. In a sense, a quant fund lies at the intersection of actively-managed equity funds and passively managed index funds. It is similar to smart-beta funds. But where smart-beta funds typically rely on a single factor to build a stronger portfolio than the index, a quant fund draws from several factors. What also works in these funds’ favour is the much lower costs they charge compared to actively managed funds.

Aparna Karnik, Senior VP & Head – Risk and Quantitative Analysis, DSP Investment Managers, says, “We believe such funds combine merits of both active and passive investing in a cost efficient manner and can play a complementary role in an investor’s overall portfolio.”

However, experts say quant funds cannot be part of investor’s core portfolio yet. Belapurkar asserts, “Actively managed funds are not dying anytime soon. Current underperformance is owing to sharp polarisation in the market, which is expected to normalise soon.” Joshi insists investors should wait for quant funds to establish a track record. “Retail investors need not consider quant funds just yet. More proliferation of quant funds with visible proof of outperformance is needed.”
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