In the age of technology can computers replace a human fund manager? That’s the new debate happening in the investment world. Can ETFs & Quant Funds be the next big thing in India?
Let’s check what are quant funds, their advantages & disadvantages are in this post.
What are Quant Funds?
A quant fund is a fund where the decisions regarding investment, stocks and securities selection, and buy and sell transactions are done based on certain models. The decisions are based on statistical or mathematical models. Models are built using software and these are applied to the quant fund.
In an actively managed fund, a fund manager makes the key decisions but in a quant fund, these decisions are automated.
But a quant fund is not like an index fund or ETF where the fund manager can be hands off. In many cases, the fund manager designs the models which are then translated into automated programs. The fund manager keeps an eye on the performance of the model and tweaks it as per market conditions and performance of the fund.
Quant funds are managed using customized software models. Therefore they are managed by cold logic and hard facts. There is not much room for emotions and biases.
These are the advantages that quant funds supposedly possess –
- There is less scope for human error as mathematical models are responsible for the investments, transactions and portfolio selection.
- The strategy and decisions are consistent with the objectives of the fund.
- There is no room for biases such as the preference for certain stocks or loss aversion. Emotions tend to cloud judgment. This can affect the profitability of the fund. Quant funds are not subject to human emotions.
- The investment process is smooth.
- The investments will be done in a systematic and disciplined way. There won’t be any instances of impulse buying or random reactionary decisions in investments due to volatility in the market or political decisions, market conditions or sentiments.
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How are they faring?
How are quant funds performing? The best way is to measure their performance against actively managed funds –
Here is a comparison of the regular quant fund and non-quant funds. Quant Active Fund and Reliance Quant Fund are quant funds –
|Name||Quant Active Fund – Growth- (Escorts)||Reliance Quant Fund – Growth||HDFC Equity Fund – Growth||Aditya Birla Sun Life Equity Fund – Growth|
|NAV||₹ 182.4792||₹ 25.971||₹ 687.905||₹ 724.95|
|6 Months Return||3.94%||6.38%||11.24%||4.17%|
|1 Year Return||3.02%||2.30%||12.66%||2.12%|
|3 Years Return||12.14%||10.87%||14.94%||13.74%|
As on June 14, 2019
Why Should I Consider?
The main reason to consider quant funds is that the decisions are objective. There is no place for subjectivity or human bias. However experienced or well-qualified the fund managers be, there is always room for temptation and errors. Some fund managers might change their position in volatile markets. Others may read economic factors differently based on their biases.
The expense ratio might be lesser for quant funds in the long run as it is more passive as compared to funds managed actively by a fund manager, though the Quant Active Fund of Escort AMC has a high expense ratio.
There are logical checks programmed in the quant funds on the amount allocated to stocks or sectors. There might be checks on the amount bought and sold as well. These ensure optimum decision-making.
Technological development has made it possible to use large sets of data, broad sets of data, and advanced analytics which help in developing more accurate algorithms for quant funds reducing the scope for errors, and improving returns.
Disadvantage of Quant Funds
They are ultimately programmed by humans and so they are as effective as the team’s capability to build the models.
They rely on historical data and we all know that past returns are no guarantee for future returns.
They have to be built in a manner that they are easily adaptable to new economic conditions or changing markets else they will not give the best returns.
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S&P BSE 200 TRI has an annualized return of 1.91% in 1 year and 13.74% in 3 years. None of the Quant have been able to match that.
Evidence has shown that these funds may not always outperform the market.
As an investor, one should not invest in quant funds just because it is based on technology and human bias is limited. An investor should look at the investment portfolio of the fund, expenses involved, and how it fits in his or her investment portfolio.
If you have any questions related to Quant Funds – you can add them in the comment section.
Hi Hemant, I am not sure how the Quant software will predict or time the market, which even the creator of Quant is not able to do. All man made systems including Artificial Intelligence (AI) have a tendency to work under pre-described boundaries and these are nothing but the limitations of a software. Although AI is trying to cross these boundaries but still a long way to establish itself. This means that under normal circumstances it will be better than humans but under abnormal conditions, Quant might not be able to take a best decision. Hence I have my doubts, not on accuracy but on consistency of results from Quant in long run.
Thanks for sharing your views & I agree with your observations.
Just wanted to know about the index funds. I have invested in one of the large cap funds but now I think the combination – ‘Nifty 50 + Nifty Next 50’ would be better than large cap funds. The main reason I see is post-categorization, most of the large cal funds will not be able to generate alpha consistently and also the expense ratio for index funds is far low than active funds.
What are your views on this?
You can go ahead with your strategy but I will still part of large cap in active funds. Right now we don’t know the risk in Index funds – for the whole world relatively it’s a new product.
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