Indian mutual funds are warming up to the idea of offering quant funds, which use complex mathematical models to pick up stocks, even as globally, quant funds are undergoing a bad patch.
Benchmark Asset Management Company Pvt. Ltd will be the second asset management company to offer a quant-based fund after Lotus India Asset Management Company Pvt. Ltd launched the first quant fund, Lotus India Agile Fund, in November.
The Benchmark India Value and Momentum Quant Fund is waiting approval from the stock market regulator, Securities and Exchange Board of India.
Benchmark’s proposed offering will be an open-ended fund. It will pick up stocks on the basis of a quantitative model designed by Citigroup First Investment Management Ltd (CFIM, a Citigroup Inc. entity. The model, known as Citi India and Value and Momentum strategy, uses complex statistical tools to try and discoverundervalued stocks that have strong price and earningsmomentum.
“The idea is to pick stocks which have good relative valuations as well as strong momentum. So, for example, in the Indian context, if there are two stocks with the same high momentum score, the model will optimize the selection by favouring the stock with the cheaper relative valuation” said CFIM managing director Harold Y. Kim.
According to him, this model when backtested would have outperformed the S&P Nifty index across time periods. For instance, over a six-month period ending December 2007, it would have given an annualized return of 165% against the S&P Nifty index’s 98%. Overa three-year period ending Decemeber, it would have given an annualized return of50% against 43% of the S&P Nifty index.
Citigroup has been offering structured products based on this strategy to its offshoreclients, but this is the first time it has tied up with an Indian fund house.
The other quant fund in India, Lotus India Agile Fund, is designed to invest in 11 stocks, selected on the basis of a proprietary mathematical model that takes into account price volume data and the market capitalization of the stocks to arrive at the stock portfolio.
Since its November launch, the fund has given a negative return of 12% and since the beginning of this year it has posted a loss of 15% against the average equity fund’s loss of 13%. “This strategy will typically work if investors have a time frame of at least one year,” says Rajiv Shastri, head of business development and strategic initiatives at Lotus. Investors have collectively invested Rs230 crore in the fund as on 31 January. Based on the same strategy, the company alsohas a closed-ended tax planning fund.
Globally, quant funds are big business. A 2006 study by fund rating company Lipper Analytics, a Reuters company, estimated quant funds assets to be around $40 billion (Rs1.57 trillion). But, quant-based strategies, especially those used by hedge funds, offered poor returns to investors in 2007.
“The performance of this category has suffered asglobally quant funds have implicit or explicit leverage in their portfolio, which helps in generating higher returns. In volatile times, the leveraged portfolio earns lesser returns,” explained Shastri.
Kim of Citigroup also said that in the Indian context, it is possible to achieve good performance without the need for leverage to boost returns, provided the stock selection process is robust. “The Benchmark fund is designed in such a way that it would not use leverage. Therefore, its risk will not be geared and its behaviour unlikely to mirror that observed for quant funds in Europe or the US,” he added.