MUTUAL FUNDS: Knowing the risks associated with quantitative funds
Quantum funds are a type of mutual fund, in which the investment and construction of the portfolio is done with minimal human intervention (fund managers) using artificial intelligence (AI), algorithmic trading, etc. Thus, to a greater extent, quantitative funds eliminate the component of human error, including emotional biases and other behaviors that normally occur in an investment. Let’s take a closer look at the mechanisms behind quantitative funds and the associated risks and whether investors should have such funds in their portfolio.
Mechanics behind quantitative funds
Quantitative funds generally use rule-based investment strategies. These funds use a variety of tools ranging from established and innovative financial models, algorithms, machine learning, AI, the use of big data, etc., to project the future price of stocks and invest. Consequently. These rules are developed by the fund managers after reviewing a significant fundamental and technical analysis. But, once the rules are defined, there is a daily involvement of the fund manager because these funds will update themselves.
However, fund managers monitor and make minor changes to the model as needed. Essentially, the models use past data and variables such as trade value, volume, volatility, beta, yield, liquidity, momentum, alpha, correlation, covariance and others. multifactor models and look for a model in order to be able to predict the future price.
Risks associated with quantitative funds
Currently in India, there are six funds — DSP Quant Fund, ICICI Prudential Quant Fund, Nippon Quant Fund, Quant Quantamental Fund, SBI Equity Minimum Variance Fund and Tata Quant Fund which operate only on the quantitative model and their collective assets. under management are worth around 990 crore.
Although quantitative funds are not biased by fund managers, the method used for stock selection is not transparent because each fund keeps its “owner” model and does not disclose it in the public space. Another risk is that the performance of these funds cannot be compared to benchmarks like Sensex or Nifty. Thus, to assess the performance of these funds, one should consider the S&P BSE 200 or Nifty 200 Total Return Index (TRI), as they will provide a clear picture of performance.
Should we invest?
As such, the concept of quantitative funds is new to India and each of the above mentioned funds has its own rules. Investors should understand each fund model and assess the benchmark for comparison of its performance before investing. Quantitative funds base their stock selection solely on quantitative data; thus, they might miss a share in the stock market due to qualitative information such as board effectiveness, business ethics and other intangible factors that are difficult to quantify.
In addition, these funds are relatively new and do not have a long track record to assess their performance and effectiveness. Thus, prudent and risk-moderate investors should preferably avoid such quantitative funds. However, aggressive investors may consider investing a small percentage of their total investment in quantitative funds as a diversification strategy.
To conclude, quantitative funds definitely have a bright future as technology as well as Indian capital markets develop and mature.
The writer is professor of finance and accounting, IIM Tiruchirappalli
Quantum funds are relatively new and do not have a long track record of performance to assess their performance and effectiveness.
Quantitative funds base their stock selection on quantitative data. Thus, they may miss out on the stock market share due to qualitative information
Cautious investors with a moderate risk appetite should preferably avoid quantitative funds. Aggressive investors may consider investing a small percentage of their total investment in quantitative funds as a diversification strategy