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Your Questions Answered: What are quant funds and how are they different from passive funds?
Quant funds are a type of active mutual fund that aim to outperform the benchmark index by using quantitative models and algorithms. Passive funds are a type of mutual fund that aim to replicate the performance of a benchmark index, such as the Nifty 50 or the Sensex.
I am a 35-year-old home maker. Our family has been investing in passive mutual funds. I recently observed that multiple mutual fund houses in India have launched a new category of mutual funds called quant funds. I understand that they use quantitative algorithms to invest in companies. However, my understanding of quant mutual funds is extremely limited. Can you please elaborate on quant mutual funds, their pros, cons and the risk associated with investing in quant funds and how they are different from passive mutual funds?
Madhu Srivastav, Jabalpur, Madhya Pradesh
At the very beginning, we wish to clarify that the category of funds known as quant mutual funds should not be confused with the Indian mutual fund house named ‘Quant Mutual Fund’. Quant mutual funds, also known as quant funds, are a type of mutual fund that use quantitative analysis and algorithms to select and manage their portfolio of stocks. Quant funds aim to eliminate human bias and emotion from the investment process and rely on data-driven models to generate returns.
How do quant mutual funds function?
Quant funds use various mathematical and statistical techniques to analyse large amounts of data and identify patterns, trends, anomalies, and opportunities in the stock market. They use computer programs to create and test different strategies and scenarios based on historical and current data. They also use artificial intelligence (AI) and machine learning to adapt and optimise their models over time.
Quant funds typically have a set of rules or parameters that define their investment objective, risk appetite, asset allocation, stock selection, portfolio rebalancing, and exit strategy. These rules are executed by the algorithms without any human intervention. Quant funds may also use techniques such as hedging, arbitrage, leverage, and short-selling to enhance their returns or reduce their risks.
How are quant mutual funds different from passive mutual funds?
Passive mutual funds are a type of mutual fund that aim to replicate the performance of a benchmark index, such as the Nifty 50 or the Sensex. Passive funds do not actively select or manage their stocks, but simply buy and hold the same stocks in the same proportion as the index. Passive funds have low costs, high transparency, and minimal tracking error.
Quant mutual funds, on the other hand, are a type of active mutual fund that aim to outperform the benchmark index by using quantitative models and algorithms. Quant funds do not follow the index, but create their own portfolio based on their rules and parameters. Quant funds have higher costs, lower transparency, and higher tracking error than passive funds.
What are the pros and cons of quant mutual funds?
Quant mutual funds have some advantages and disadvantages compared to other types of mutual funds. Some of the pros are:
- Quant funds can process large amounts of data faster and more accurately than human fund managers.
- Quant funds can eliminate human errors, biases, emotions, and conflicts of interest from the investment process.
- Quant funds can exploit market inefficiencies, anomalies, and opportunities that may be overlooked by human fund managers.
- Quant funds can diversify their portfolio across multiple factors, sectors, styles, and markets.
- Quant funds can adapt and optimise their models based on changing market conditions and feedback.
Some of the disadvantages associated with quant mutual funds are as follows:
- Quant funds may not be able to capture qualitative aspects of investing, such as rate governance, social responsibility, and investor sentiment.
- Quant funds may face technical glitches, data errors, model failures, or cyberattacks that may compromise their performance or security.
- Quant funds may face regulatory challenges, ethical issues, or legal disputes related to their use of data, algorithms, or techniques.
- Quant funds may face competition from other quant funds or market participants who may use similar or superior models or strategies.
- Quant funds may face periods of underperformance or volatility due to market disruptions, regime changes, or black swan events that may not be captured by their models.
Which type of investors should invest in quant mutual funds?
Quant mutual funds are suitable for investors who:
- Have a long-term investment horizon of at least 5 years.
- Have a high risk appetite and can tolerate volatility and uncertainty.
- Have a high trust in technology and data-driven decision making.
- Have a low need for transparency and control over their investments.
- Have a high interest in innovation and experimentation.
Quant mutual funds are not suitable for investors who:
- Have a short-term investment horizon of less than 5 years.
- Have a low risk appetite and prefer stability and certainty.
- Have a high reliance on human judgement and intuition.
- Have a high need for transparency and control over their investments.
- Have a low interest in innovation and experimentation.
Conclusion
Quant mutual funds are a new and emerging category of mutual fund that use quantitative analysis and algorithms to select and manage their portfolio of stocks. They offer a unique value proposition for investors who are looking for an alternative way of investing in the stock market.
However, they also come with some challenges and risks that investors should be aware of before investing in them. As with any type of mutual fund, investors should do their own research, understand their goals and risk profile, compare different options, and consult a financial advisor before investing in quant mutual funds.
Kuvera is a free direct mutual fund investing platform.
Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.
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First Published:21 Jul 2023, 08:42 AM IST
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