Weekly Musings – NFO Pick (Aditya Birla Sun Life Quant Fund)

8 Jun 2024 , 10:07 AM

WHAT EXACTLY IS A QUANT FUND AND WHY?

As the name suggests, a quant fund is a fund that uses statistical black box models for arriving at portfolio allocation and rebalancing. Quant funds do not entirely replace manual fund management, but reduce the human discretion aspect by building algorithmic rules based on extensive back-testing. Most quant models are proprietary and hence not too much of details out be available in the public domain. The role of quant funds was best explained by the MIT economics professor, Dr Richard Bookstaber, “No man is better than a machine and no machine is better than a man with a machine.” That perhaps sums up the power of quants in investing. It not just offers a way to redefine investing, but heavily leverages the left brain of the machine and the right brain of human mental expanse.

KEY MERITS OF QUANT BASED INVESTING

It would be a futile debate whether man or machine does the job of investing better. What matters is that quant based investing adds value to the investing process in a number of ways.

• Since the models are quant and data based, they are largely devoid of the emotion that can often force wrong decisions in the market.
• Quants are flexible in the sense that they can not only be conceived with machines, but also executed with machines for best possible results.
• Back testing is one of the big advantages of quant investing. While back-testing does not assure results, it does reduce the chance of errors to a large extent.
• Quant investing is largely rule based and entry and exits are based on pre-defined rules. This ensures that the sum total of decisions is always favourable.
• While the model is a black box model, the rules are quite transparent and hence the investor know how the funds are being allocated.
• Algorithm based investing has a lot of inbuilt risk management features and constant monitoring by humans and machines, makes the process largely fool proof.

To sum up, quant investing does proffer some unique advantages to the investors.

HOW THE ADITYA BIRLA SUN LIFE QUANT FUND WILL WORK?

The ABSL Quant Fund will look to combine use proprietary signals coming from a combination of fund manager inputs, wisdom of crowds, sell-side revisions, and stock quality. As the first starting point, the top 75 stocks of the top 15 fund houses will be the assumption. Then the quality test will be done focusing on companies with strong track record for last 5 years. Then the momentum factor will be used in terms of 6-month returns, consistency in returns, chart signals etc. Finally, the sell side revisions based on change in EPS, EBITDA and revenues estimates and forward guidance will be factored in. Based on all these parameters, the final list of about 45-50 stocks will be distilled, which will form the starting investment universe of the fund.

ABSL QUANT FUND – AUTO PILOT PLUS FUND MANAGER INTERVENTION

While the algo based quant fund will largely be on autopilot, there will be occasional intervention from the fund manager to factor in expert inputs which the automated algo cannot provide. The buy/sell discipline will be such that the stocks will be divided into 5 quintiles. Stocks top quintile will be part of the portfolio. Stocks will remain in the portfolio till it is in the third quantile. When the stock gets into fourth or fifth quintile, the sell signal as part of the rebalancing is triggered. The back-testing of the algorithm has demonstrated that the quant model has outperformed the NSE 200 under all time frames of 1 year and more. In fact, on a 3-year basis, the model generate alpha 94% times and over a 5 year period it generated alpha 99% of the times. Cash levels will be always minimal.

PERFORMANCE OF QUANT FUNDS IN INDIA

Here is a quick look at how the Quant Funds have performed over a 1 year period and a 5 year period. One is a short term view and the other is a slightly longer term view. In both cases, we have considered the direct plans to ignore the impact of the total expense ratio (TER) on the returns of the fund. While there are 29 Quant Funds in India, in our ranking below, we have only covered the top-15 by 5-year returns. We have not considered 3 year plans as that is not long enough for a Quant Fund to perform. We also avoided returns since inception as the periods can vary substantially. We also dropped funds that did not have the required history The ranking below is on 1-year returns pertaining to Regular Plans.

Scheme Name	NAV Regular	Return (%) 1-Year	Return (%) 3-Years	Returns (%) Launch	Daily AUM (₹ in Crore)
Quant Quantamental Fund	24.03	64.12	31.07	32.53	2,359.09
360 ONE Quant Fund	17.61	57.48	25.16	25.16	259.49
Nippon India Quant Fund	64.01	41.43	21.16	12.08	65.68
ICICI Prudential Quant Fund	20.37	34.01	16.31	22.63	82.40
Axis Quant Fund	15.67	32.91	16.52	16.52	1,050.29
Tata Quant Fund	14.42	26.80	11.33	8.73	59.05
DSP Quant Fund	19.92	20.29	10.33	14.79	1,163.36

Data Source: AMFI

The table above provides the performance of Quant Funds over 1-year time frame, 3-year time frame, and since inception. The average benchmark return for each time period will be used to compare in our analysis. Quant Funds are not a class of funds, but they are a sub-category within thematic funds and this is classified as an equity oriented funds. There are a total of 7 business cycle funds in India managing a total AUM of just about ₹5,040 Crore, and Aditya Birla Sun Life Quant Fund NFO comes at a time when all the 3 indices viz. large cap index, mid cap index and the small cap index are trading very close to their peak levels. Here is a sneak peek.

• Let us first look at the returns on Quant Funds over a 1-year period. On a 1-year returns basis, Quant Funds  generated maximum returns of 64.12% and minimum returns of 20.29%, which is fairly appreciable considering the fluid nature of the fund. The average returns over a 1 year period are 39.58%, which is impressive. Dispersion in this segment on a one year basis is high; but that can be attributed to the fact that these quant funds are based on proprietary algorithms and hence there could be wide variations.
• How do these quant funds compare on 1-year returns with the benchmark? While the average 1-year return on quant funds has been 39.58%, the benchmark return is 33.49%. The average returns of quant funds have beaten the benchmark by 609 bps. Out of the 7 quant funds in India, 4 funds gave returns above the benchmark, giving a success probability at alpha of 57.14%.
• Let us now look at the returns on Quant Funds over a 3-year period. On a 3-year returns basis, Quant Funds  generated maximum returns of 31.07% and minimum returns of 10.33%, which shows fairly wide dispersion in returns. The average returns over a 3-year period was 18.84%, which is impressive. Dispersion in this segment on a 3-year basis is high; but that can be attributed to the fact that these quant funds are based on proprietary algorithms and the impact is magnified over time.
• How do these quant funds compare on 3-year returns with the benchmark? While the average 3-year return on quant funds has been 18.84%, the benchmark return is 17.23%. The average returns of quant funds have beaten the benchmark by 161 bps. Out of the 7 quant funds in India, 3 funds gave returns above the benchmark, giving a success probability at alpha of 42.86%.
• Let us finally look at returns on Quant Funds over since launch. Since launch, Quant Funds  generated maximum returns of 32.53% and minimum returns of 8.73%, which is more due to varying gap since launch. The average returns since launch are 18.92%, which is impressive. Dispersion in this segment on a one year basis is high; but that can be attributed to the fact that the time since inception may vary widely.
• How do these quant funds compare on returns since launch with the benchmark? While the average return since launch on quant funds has been 18.92%, the benchmark return is 18.18%. The average returns of quant funds have beaten the benchmark by 74 bps. Out of the 7 quant funds in India, 3 funds gave returns above the benchmark, giving a success probability at alpha of 42.86%.

To begin with, the overall AUM of quant funds is quite small, but it is likely to grow. The performance shows that it is an idea that has worked and the numbers are there to see. However, it may eventually boil down to the quality of these proprietary algorithms.

GLANCE AT THE ADITYA BIRLA SUN LIFE QUANT FUND NFO

Here are some details of the Aditya Birla Sun Life Quant Fund NFO you must know to decide on investing in the fund.

a. The NFO of Aditya Birla Sun Life Quant Fund opens for subscription on June 10, 2024 and will close on June 24, 2024. Being an open-ended equity oriented thematic fund, it will reopen for sale and repurchase anywhere between 3 days and 15 days of NFO closure. While the fund has no lock-in period (other than the conditional exit load disincentive), it is suggested to hold such Quant Funds for a period of 5 years and above to get full benefits of the algorithms working in favour of the investors.

b. On the Standard SEBI Risk-O-Meter, the Aditya Birla Sun Life Quant Fund will be ranked as a Very High Risk Fund. The high risk is due to the predominant exposure to equities that the Aditya Birla Sun Life Quant Fund will have. In addition, there is also the risk of entering into the fund when the market is at all-time high levels. The fund will be based on back-tested black box quant models. However, there are the outside risks of such algorithms not serving the desired results.

c. The Aditya Birla Sun Life Quant Fund is about long term capital appreciation through the use of equity. The stock selection will be based on proprietary quant models, and the workings of such quant models are only broadly available. While as an equity fund, it must maintain at least 65% exposure to equity, the Aditya Birla Sun Life Quant Fund plans to allocate, at least, 80% to equities.

d. Investors can invest in the NFO of Aditya Birla Sun Life Quant Fund in minimum size of ₹500 and in multiples thereof. This also applies to switch-ins during the NFO while additional purchases can be in such multiples too. There will be an exit load of 0.5% of applicable NAV if redeemed within 90 days. There is no exit load on redemptions beyond 90 days. However, investors are advised to hold Quant Funds for a minimum period of 5-7 years to get full benefits of the theme.

e, The Aditya Birla Sun Life Quant Fund does not give any guarantee on returns, being an equity oriented and market risk driven fund and there is no assurance of any minimum return on the fund or that the algorithms will deliver the goods. The fund has the discretion to spread across equity, debt, derivatives, and liquid assets to enhance the risk-adjusted returns; keeping a base minimum exposure of 80% to equities at all times.

f. The Aditya Birla Sun Life Quant Fund NFO will offer the growth option and the IDCW (income distribution cum capital withdrawal) option. Within the IDCW option, the fund will offer dividend payout and the dividend reinvestment option. The Aditya Birla Sun Life Quant Fund will offer investment via the Regular Plan or through the Direct plan. The NAVs on redemption will be different for regular plans and direct plans based on TER. NAVs of growth funds and IDCW funds will differ by amount of dividends.

g. The performance of the Aditya Birla Sun Life Quant Fund will be benchmarked to the underlying Nifty 200 TRI index. The TRI (total returns index) is more reflective as it includes the impact of dividends and capital movement. The benchmark will used to evaluate fund performance; although it is advisable to also consider risk-adjusted return measures like Sharpe and Treynor for a granular picture of risk. The fund managers for the Aditya Birla Sun Life Quant Fund are Harish Krishnan and Dhaval Joshi (dedicated for overseas investments).

h. The Aditya Birla Sun Life Quant Fund will be classified as an equity fund for tax purposes; as long as its equity exposure is decisively above 65%, which is the intent. The short term capital gains (held for under 1 year) will be taxed at 15% while long term capital gains (held for over 1 year), will be taxed at a flat rate of 10% beyond a minimum threshold exemption of ₹1 Lakh per financial year. There will be no indexation benefits on long term capital gains.

The Aditya Birla Sun Life Quant Fund NFO offers an opportunity for investors to participate in a multi-cap equity fund wherein the stock selection philosophy and the stock rebalancing will be driven by quantitative driven (quant) algorithmic models.