Quantitative funds minimise human errors in investments

What are Quant Mutual Funds, and are they more lucrative than regular Mutual Funds?

- T Shyam Nandyal

Quantitative funds are a type of mutual fund commonly referred to as quant funds. Quantitative funds are comparable to semi-active and semi-passive investing. In essence, technical innovation, automation, and other technological resources are being used in the mutual fund sector in the form of quantitative funds. Quantitative funds are operated on impersonal decision-making. Quantitative funds are gaining momentum and have grown remarkably popular in India. Reliance Quant Fund is the first quantitative based mutual fund scheme in India that came into existence in 2008. The name of the Mutual Fund was changed from Reliance Mutual Fund to Nippon India Mutual Fund, effective 28 September 2019. There are many quantitative funds available now, including Axis Quant Fund, DSP Quant Fund, ICICI Prudential Quant Fund, Nippon Quant Fund, Quant Quantamental Fund, SBI Equity Minimum Variance Fund and Tata Quant Fund.

Investment strategies and portfolio construction in quantitative funds are generally done using rule-based investing strategies. The algorithm in these types of mutual funds generates a templated portfolio, often known as a quantitative fund model portfolio. Quantitative funds depend on different tools such as Artificial Intelligence, computer algorithms, Big Data, machine learning, innovative financial models, statistical metrics, and other quantitative techniques to project future prices and trends and invest accordingly. These algorithms, financial tools and financial models consume past data and wield alpha, beta, correlation, covariance, momentum, trading volume, volatility, value, yield and other variables that have been proven throughout time. Usually, most quantitative funds use either single-factor or multi-factor models. Quantitative models only choose stocks based on predetermined techniques and strategies. Some high-potential stocks may get disregarded due to preset quantitative models and parameters if it does not satisfy the yardstick and touchstone.

These strategies are chalked out by the fund manager while taking technical and fundamental analysis into consideration. There will be minimal human intervention, and the role and involvement of fund managers will be minuscule and limited to passively monitoring after the rules are set. Quantitative funds are free from fund manager bias, as the funds will be on auto-pilot and updated on their own. Hence, quantitative funds eliminate human errors, behavioural biases, and human emotions usually occurring in the investment process. These funds also help reduce investment biases which impact investment decisions. Quantitative funds may be considered an intelligent choice and thoughtful approach, which is shrewd enough to diversify the portfolio during market turbulence. Not only do these quantitative funds use algorithms while investing, but also employ data-driven strategies to make investment decisions. This is why these funds minimise the chances of human errors and human emotions. They funds provide a more systematic approach to managing risk. Further, they often employ a wide range of investment strategies and investment instruments. As a result, quantitative funds usually help diversify portfolios and reduce overall risk. On the other hand, these investment vehicles allow investors to try and get exposed to a wide range of industries and assets.

Quantitative funds have the ability to outperform traditional investments and conventional asset classes during market up-and-down and uncertainty. Investments in these funds may offer returns not associated with those of equities and bonds, and other traditional asset classes since they usually have a low correlation with conventional and other asset classes. That's why these funds typically do not move in the same direction as the overall market and have the ability to shift allocation based on market direction. Thus, these funds acts as an extra insulation or additional layer of protection during unsteady times and volatile markets. Consequently, the performance of the Quantitative mutual funds cannot be compared with Sensex, Nifty and other benchmark indices. Quantitative funds are not immune to volatility, nor can they protect the losses from a rollercoaster-like market. However, investors must consider both regular and quantitative funds in order to benefit from both kinds of funds in their portfolios. There are flip sides to quantitative funds as well. When opposed to regular funds, the method used in stock selection, building portfolios and other strategies employed in quantitative funds lack transparency. Each quantitative mutual fund keeps its model proprietary and exclusive and rarely discloses its secret recipe in the public domain. Quantitative funds may take considerable time to generate handsome returns and lucrative rewards. Reducing human biases and dependency on automation does not always assure high returns. Like regular mutual funds, quantitative funds do not guarantee returns. Like regular funds, quantitative funds are also vulnerable to market risks and economic downturns. Quantitative funds are suitable for investors with long-term horizons and a high-risk tolerance.

(The author is a SEBI licensed Research Analyst. The alumnus of the Indian Institute of Foreign Trade (IIFT), he had held leadership roles at National Geographic, Reliance Radio Television Luxembourg, STAR TV)