Can we invest in Quantitative Mutual Funds (Quant Mutual Funds)?

Published: July 3, 2020 at 10:47 am

The SEBI MF categorization rules have many loopholes. Among these, there is no limit on the number of thematic funds an AMC can offer (unlike large cap, mid cap etc). This is the reason for increased thematic NFOs, some of them being quantitative mutual funds aka quant mutual fund. In this article, we discuss what these are and if we can invest in them.

First of all, when the term quantitative mutual fund is abbreviated as  quant mutual fund, it is not a reference to the AMCs quant mutual fund or quantum mutual fund. With that out of the way, let us start from the basics.

What is a quant mutual fund? A mutual fund that either completely or partially uses quantitative rules to determine its asset allocation and/or its portfolio is a quant mutual fund. These rules can be based on measures associated with the broad market or a company (eg. PE or PB) or technical indicators like moving averages or fancier metrics.

Is a NIfty or Sensex ETF or index fund a quant mutual fund? Yes. Technically it would be hard to dispute that although few appreciate it.  Market capitalization indices like Sensex, Nifty 50, Nifty Next 50 etc are completely rule-based both in the stock selection and allocation of weights. That is as quantitative as it gets! However, we tend to assume only those with “fancier” rules are quant mutual funds.

What are some quant mutual funds in India? All market capitalization based index funds and ETFs are quant funds. All dynamic asset allocation funds are typically quant mutual funds. Examples are DSP Dynamic Asset Allocation, IDFC Dynamic Equity, Motilal Oswal Dynamic Fund  Some balanced advantage funds like ICICI Balanced Advantage are partially quant-based funds. A multi-asset fund like ICICI Multi-asset is also partially quant-based.

All factor-based or smart-beta ETFs and index funds are quant funds: Equity-weight indices from DSP (NIfty 50), Sundaram (Nifty 100) and Principal (NIfty 100), Edelweiss ETF – Nifty 100 Quality 30, ICICI Pru Nifty Low Vol 30 ETF, ICICI Pru NV20 ETF, Kotak NV 20 ETF, Nippon India ETF NV20 and SBI ETF Quality.

Then there are the newer “thematic funds” like SBI Minimum Variance Fund, DSP Quant Fund, Tata Quant Fund which are paraded around as if they are the only quant funds with a lot of mumbo-jumbo about AI, machine learning, neural networks. We shall refer to them as thematic quant funds.

To get an overview of normal indices, smart-beta indices, index funds and ETF options available, the reader may consult this talk.

Can we invest in Quantitative Mutual Funds?

Thematic Quant Funds: First, we need to recognise that an AMC would do anything to get AUM, even ridiculing their own fund management teams. If they want to launch a NIfty or Sensex fund, they would have no problem talking about how difficult it has become for active funds to beat index funds: DSP Nifty 50 Index Fund & DSP Nifty Next 50 Index Fund: Avoid & Watch

If they want to launch a quant fund, they have no problems saying normal active funds managers are subject to emotional, behavioural bias. This, when their portfolios are loaded with normal active funds. This is like parents saying, we have decided to make a new baby because our existing ones are flawed.

Second, we need to understand that these thematic quant funds revel in withholding full details of what they are trying to do. While they are within their rights to do so, investors must recognise that the NSE and BSE have all kinds of smart-beta indices (see my talk above) that would cover a good chunk of the strategies advertised by these funds.

They could have simply created a low-cost index fund based on these indices. Instead, some of them choose to start ETFs  – which are barely traded and should be avoided -and some of them start actively managed quant funds to gain profit. This alone is enough to reject thematic quant funds.

Dynamic Asset Allocation Funds: Here the asset allocation rules are well known. Security selection though is active. They either pick stocks or invest in other funds (fund of funds). Clearly this is a lesser evil and mature investors who prefer lower risk (during a bull run) can consider these: Do not invest in dynamic equity funds if you wish to chase returns. Also see: Dynamic Mutual Funds vs Balanced Mutual Funds

However, AMCs have a tendency to suddenly change the asset allocation rules. Maybe because they do not work or the fund is drawing in AUM.  DSP Dynamic Asset Allocation fund did this. They suddenly removed yield gap from its rules and replaced it with 50 and 200 DMA. IDFC dynamic equity removed 200 DMA from its rules and stuck to PE! Old rules are here: IDFC Dynamic Equity Fund: Investment Strategy Analysis. Also,  L&T Dynamic Equity Fund removed its PE-based rules!

Franklin Dynamic PE fun has an excellent track record:  NIfty-like returns with almost 50% lower risk: Want to time the market with Nifty PE? Learn from Franklin Dynamic PE Fund. They too suddenly decided to include PB into the rule mix from Oct 2019. This is too arbitrary for comfort.

Balanced advantage funds: These are actively managed funds with a quant component (in some of them). So face the standard active fund risk of sustained underperformance.

Smart-beta (strategic funds, only ETFs as of now): These are subject to data-mining risks as noted here: Data Mining in Index Construction: Why Investors need to be cautious. The random changes in investment strategy mentioned above and hocus pocus associated with thematic quant funds could well be examples of data mining.

Data mining here refers to, cherry-picking investment strategies, presenting results over a narrow time period, inadequate backtesting, flawed backtesting among others. Essentially it is analysis with a conflict of interest. Ps. Conflict of interest is everywhere even in academia. For example, a PhD student eager to get a degree. So there should be no surprises when hundreds of crores of profit are involved!

The only quant fund that an investor can safely invest in is one based on a low volatility index. This guarantees lower risk and may outperform (say, the Nifty) from to time. This is not available as an index fund and is unlikely to be.

Therefore the only quant fund an investor can safely choose is a normal Sensex, NIfty or Nifty Next 50 index. It may seem hard to believe, but they are quant funds too!

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About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association, IIST Alumni Association. For speaking engagements write to pattu [at] freefincal [dot] com
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