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Does investing in quant funds make sense now?

Does investing in quant funds make sense now?

Your mutual fund manager is not the only one who can help you pick and choose stocks. Even computers, these days, can sift through hundreds of stocks, based on a complex mathematical formula that is fed into them, and arrive at the ones they think you should put your money in. That is what quantitative or quant funds do.

India’s first quant fund—Religare AGILE Fund (RAF; formerly, Lotus India AGILE Fund)—is about to complete two years. But its track record, so far, has been uninspiring. The only other one, Reliance Quant Plus Fund (RQP; earlier Reliance Index Fund) isn’t much better.

Poor performance

Though quant funds have been popular abroad (about $1.5 trillion lie in these in developed markets), many took a beating in the 2008 market crash. In India, quant funds haven’t really taken off. RAF underperformed its benchmark, Nifty index, and diversified equity funds by 6 and 5 percentage points, respectively, in 2008. Rising markets in 2009 haven’t helped it much either. Religare’s fund has returned 45% against 73% by the Nifty and 75% by equity funds. Reliance’s fund did better—it lost just around 36% last year (since the time it got converted into a quant fund), but has managed to give 74% so far this year.

Reality check

Typically, quant funds test the portfolio over the past 10 or 15 years and run simulated schemes to see if the model works. This is largely based on the assumption that the market would move the way it did in the past. And that’s its biggest drawback. Says US-based mutual fund tracker Morningstar’s associate director of fund research, Michael Herbst: “Traditional models have not been too effective at predicting the kind of market turmoil we saw in recent years. Because they are built on historical data, many will fight the last war in terms of preparing for the last market crisis instead of the next one."

So, the fund manager may not like a stock, but doesn’t usually have a choice. For instance, despite Religare’s fund holding on to Punjab National Bank in 2009, Religare MF’s diversified equity fund sold the scrip. “The kind of volatility we saw last year would not have been predicted by quant models even if they had studied market movements for the past 10 years," says Vetri Subramaniam, fund manager, RAF.

Volatility, such as the market crash of 2008 followed by a sharp recovery in 2009, is said to be the single largest enemy of quant funds. Despite markets having recovered since early 2009, it took a few months for RAF’s quant model to adjust to the trend and pick the right stocks. After lagging for the first six months of 2009, RAF picked up—it returned 16% in the past three months, outperforming all other large-cap equity funds.

Some quant funds such as RQP prefer to have some active management. After shortlisting 20 scrips on parameters such as price movement, sales growth, profit figures and earnings per share, the fund manager gets to decide how much he wants to invest in them. The fund manager can also look beyond these 20 scrips if he doesn’t feel confident investing in the ones the formula throws up. “We aim to beat the index," says fund manager Krishnan Daga.

Despite claiming to limit or, in some cases, absolve you of the fund manager’s risk as compared with a normal equity fund, quant funds aren’t as passive as index funds. You are still at the mercy of the computer model devised by your fund house. Also, their passiveness comes at a cost. While RQF charges an expense ratio of 2.5%, RAF charges around 2.4%—almost the maximum an equity fund can charge—thanks also due to a small corpus size.

Should you invest?

Not all quant funds are avoidable though. Apart from the model itself, what differentiates one from the other is also how effective the model is under various market conditions and how much the fund house is willing to invest in maintaining the model. Yogesh Kalwani, head (investment advisory), BNP Paribas-Private Banking, however, points out, “Developed markets have a long history, are far more efficient and hence provide more evidence. Indian markets lack depth in terms of volumes and transactions and hence quant models do not effectively project future market trends."

Ultimately, the proof lies in the pudding. As quant funds seldom reveal their models, you wouldn’t know for sure their efficacy unless you have seen their track record. Further, Indian markets are expected to experience high bouts of volatility time and again. Unless your quant fund proves its track record across market cycles, you better stick to index- or exchange-traded funds if you want to avoid fund manager’s risk or diversified equity funds if you prefer active management.

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