Eliminating Human Error.
Technology has become central to our lives. It is also increasingly driving the way we invest. Quant funds use algorithmic, or algo, trading, in which computer software takes buy/sell decisions on the basis of preset formulae after extensive data crunching.
The process involves use of advanced mathematical models-based on parameters such as price movement, volume, earnings, financial ratios and growth-to take decisions in the market.
"Quant funds have a data-driven approach. Typically, there is a model that automatically selects stocks based on various data inputs that may or may not include fundamental data," says Vetri Subramaniam, chief investment officer at Religare Mutual Fund.
Like equity funds, quant funds have variants such as large-cap and mid-cap. They are popular with portfolio management services.
Quant funds are at a nascent stage in India. "Quantitative funds work best when you have a large liquid market, particularly for long-only quantitative investing. India has about 100 stocks with large trading volumes. This will increase as liquidity improves," says Sandeep Tyagi, chairman and managing director, Estee Advisors, which offers quant funds under its portfolio management service.
QUANT Vs REGULAR
Fundamental analysts say a computer cannot replace human intelligence. To this, quant fund managers say their model does involve human intelligence and the use of algorithms merely eliminates human error in the process of investment.
"A team of analysts suggests companies after which the fund manager builds a portfolio. Quant funds, however, screen all companies which fit their criteria and see which sectors and stocks are doing well. It's a more objective approach," says Vikaas Sachdeva, chief executive officer at Edelweiss Mutual Fund.
This eliminates the fund manager's authority to choose a stock. The system will pick the stock only if it fits the criteria fed into the fund's model.
"There is no attempt to understand the nature of the business and the company. Quant fund managers may never meet managements of companies they invest in. There is no human intervention after the model has selected the stocks and created the portfolio," says Subramaniam.
Another negative is that quant funds may not be able to take into account the impact of unforeseen changes. This is because unlike regular funds, quant funds use a lot of assumptions which involve historical stock prices, volume growth, earnings, etc.
So, if a stock does not follow historical patterns, there are chances the model will fail to predict its movement. Also, a quant fund will usually not buy even a good stock if trading volumes are not adequate.
"There are stark differences in the performance of quant funds. The investor should look at returns over a long period, as well as consistency of returns," says Sachdeva.
Over the past three years, quant funds have generated an average annual return of 7 per cent with Religare Agile returning 8 per cent. Edelweiss EDGE Top 100 gave the second highest annualised return of 7.7 per cent.
In the year ended June 13, quant funds lost 2.1 per cent value with Reliance Quant falling over 6 per cent.
"Quant strategies adopt varying strategies and each of these has unique performance characteristics. For example, our quant fund's performance (alpha) is significantly affected by volatility. Its performance is better during periods of normal or low volatility and weaker during high volatility," says Subramaniam.
Returns from quant funds vary widely. So, investors should look at funds' past record. Globally, quant funds have a record of giving downside protection but failing to match returns from regular funds, say experts.
"These funds are more suited for conservative investors,"says Sachdeva of Edelweiss.
"A well-run quant fund will have lower volatility. Investors should look at volatility and then choose," says Tyagi of Estee Advisors.
To sum it up, quant funds are a way to diversify the portfolio and not a substitute for regular funds.
Reproduced From Money Today. Copyright July 2012. LMIL. All rights reserved.
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