Read this before you put money into quant funds!

Quantitative investment is gaining traction not only in India but throughout the world. Continue reading to find out if it makes sense to invest in them.

Globally, quantitative investment is gaining traction. India is not far behind, with roughly four quant funds launched in the last year. What is it about it that makes it so popular? The following example will help you better understand the trend.

Over a 30-year period from 1988 to 2018, one fund achieved an annualised return of more than 66 per cent before costs and 39 per cent after expenses. This is the Medallion Fund, which is managed by James Harris Simons, the creator of Renaissance Technologies, who has earned the title of finest money manager on the planet for achieving such outstanding results.

The fund is presently exclusively available to Renaissance Technologies employees and a few other persons related to the company. It's worth noting that this organisation creates and manages its portfolio using quantitative and statistical methodologies. In this case, they use computer models and algorithms, as well as large amounts of data, to forecast future prices of certain security.

Furthermore, it removes human mistakes in security selection by keeping behavioural biases away, which impair the fund's performance in some manner. However, it is important to remember that these quant models are created by people.

What are quant funds?

Quant funds are mutual fund schemes that use rule-based investing to short-list and create stock portfolios. As they use a number of pre-determined filters to choose companies, these funds have a minimum responsibility of a fund manager. The fund manager's responsibility here is to examine the model annually and, if required, change it.

According to a 2015 Morningstar research, exposure to broad market variables such as value, momentum, yield, volatility, liquidity, and size – all of which are essentially quantitative factors – generates 65 per cent of alpha, while stock selection - fundamental analysis and human judgement – generates the remaining 35 per cent. As of February 2022, there are five funds in India that use a quant methodology, with a total asset under management (AUM) of Rs 3,035.2 crore.
 

The preceding table clearly illustrates that quant funds generally struggle to outperform their benchmark, whereas funds such as ICICI Prudential Quant Fund and Nippon India Quant Fund were only matching the performance of their benchmark. They do, however, take less risk than the benchmark when it comes to risk. Overall, in terms of risk and return, it makes sense to invest in them, but only as a portfolio diversifier.