Weekly Musings – NFO Pick (Kotak Quant Fund)

9 Jul 2023 , 09:15 AM

Globally, quant funds are popularly referred to as black box funds, largely because it is believed that these fund are based on esoteric formulae and algorithms which most people cannot understand. However, there is a method to the madness in these quant funds. Most of these quant funds are based on certain assumptions and a belief that tested empirical data of the past would be fairly reflective of the future movement of prices. 

In quant funds, the human role in fund management is very limited except for testing and approving the algorithms and logic for various automated fund selection criteria The Kotak Quant Fund will open for subscription on July 12, 2023 and it will close for subscription on July 26, 2023. Quant funds are classified by AMFI as thematic funds, but in reality these quant funds would rank somewhere between an active fund and a passive fund in terms of structure.

What are quant funds and how do the work?

A quant fund is a type of mutual fund that makes its stock picking decisions based largely on mathematical and statistical models or pre-determined algorithms. These algorithms are the methods used to arrive at an investment decision. For example, the investment committee of the fund can decide that a certain fund would only invest in stocks with a ROE of more than 15%, P/E of less than 15X and profit growth of minimum 20% over last 5 years. 

Typically, every quant fund runs its own proprietary models and the finer details of the model’s workings are normally kept confidential. The good thing is that these proprietary system-based models are built around certain set criteria, so human judgement is reduced to a large extent, which is what makes such quant funds a mix of active and passive funds. Typically, quants use these algorithmic models as inputs to shortlist and identify stocks and then there is small element of judgement in taking the final decision on the stock.

Here is how a quant fund would typically work. The algorithm for the quant fund is based on certain inputs which are predicated on set rules and the resultant output is used for portfolio structuring. The fund manager makes investment decisions based on the output generated. Since the models are well thought through and deliberated upon, not much of back-end judgement is involved in such funds. This reduces human bias and human discretion to the extent possible. Quant funds can be designed based on valuation ratios, market capitalisation, sectoral indicators, growth, profitability etc. Most quant funds are complex multiple regressions based on a plethora of variables. Once the methodology is set and signed off, the fund manager just tries to replicate the algorithm logic in the portfolio.

What are the advantages of investing in a quant fund?

While a quant fund may sound quite esoteric to begin with, these funds have certain unique advantages too. Here are a few of them.

• The quant fund does not eliminate human judgment and human discretion totally. However, it does reduce human judgement to the bare minimum. Now, this has certain advantages. Firstly, even with the best of training, human minds tend to be conditioned by experiences and hence can be subjective and irrational at times. Decisions based on sentiments can negatively impact fund returns and that is something that the quant funds resolve. 

   

• Quant funds can be scalable based on how they are built. This is an interesting point to note. In a typical active fund, the infrastructure required to manage a Rs30,000 crore fund is much bigger than the infrastructure needed to manage a Rs2,000 crore fund. On the other hand, the quant funds are agnostic to the size of the fund. Once the logic of the fund is set, then it does not really matter whether the funds manage a small corpus or a large corpus?  Big data analysis makes scaling more democratic in quant funds.

   

• Decision-making in the quant investing space tends to be quicker and more objective as it relies on back-tested models. Some argue that quant models are based on rules and hence it can become tricky in volatile markets. But, that is the whole idea of quants. The assumption is that if you follow certain back-tested models the risk of bad decisions can be reduced and the entire decision making process can be easily replicated.

   

• Quant funds also tend to be lower on the cost scale. That is because, since the investments are one-time and the operation of such funds is predominantly passive, they can afford to charge lower fees, thus passing on the benefits to the end unit holder. We have seen that reduction in the TER (total expense ratio) can be a major factor enhancing returns on a fund. 

Quant funds available in India

There are several quant funds already available in India right now and these are all based on such algorithmic models or black-box models that are extensively back tested. Here is a quick analysis of quant funds available in India.

Scheme  Name	1 Year  Returns	1-year  Benchmark	Returns  from start	Benchmark Returns	Daily AUM  (Rs Crore)
Quant Quantamental Fund	40.40	21.46	24.17	15.57	777.78
ICICI Prudential Quant Fund	18.32	20.68	20.13	17.31	59.26
DSP Quant Fund	17.29	20.68	15.05	15.03	1,269.82
Axis Quant Fund	29.77	20.68	13.27	11.95	1,009.05
360 ONE Quant Fund	34.18	20.68	12.89	9.23	62.48
Nippon India Quant Fund	28.72	20.68	12.71	14.43	40.38
Tata Quant Fund	24.84	20.68	6.19	16.91	40.18

Data Source: AMFI

The quant fund space is quite small in India. The seven existing quant funds put together manage just about Rs3,259 crore. There are only 2 funds out of the 7 quant funds that manage more than Rs1,000 crore. We have not covered 3-year returns and 5-year returns since most of the quant funds in India were only launched in the last 2-3 years. Hence, we have only considered 1-year returns and inception returns.

If you compare the 1-year returns with the benchmark, then 5 out of the 7 funds have beaten the benchmark. In fact, last on year returns have been fairly attractive even on an absolute basis. If you consider the returns since inception, then 4 out of 7 quant funds have done better than the benchmark. However, it must be noted that the overall AUM of the quant fund universe still too small and it remains to be seen how these quant funds sustain these returns once the corpus starts picking up.

Who should opt for the Kotak Quant Fund

This fund would be a perfect fit for investors with a slightly higher risk appetite and who are willing to bet on such mathematical models.

• Ideally, such strategies take time to fructify and hence, like any other equity funds, this is best suited to investors who have at least 5 years perspective in investing. In the short tun, investors could be disappointed. 

   

• The Kotak Quant Fund is best suited to investors who are better informed and have the ability to understand the implications of such models. Most of these algorithms are pretty tough to grasp for small investors and such investors should ideally stick to passive index funds or active diversified funds.

   

• At the end of the day, quant is still a theme and so quant funds are thematic funds. Hence all the risks of a narrow focus thematic fund exist in the quant fund also. It may not be a sectoral risk but it is still a logic risk that these funds run. Hence, only investors who are comfortable with assuming such risks should get into the Kotak Quant Fund.

Glance at the Kotak Quant Fund NFO

Here are some details of the Kotak Quant Fund NFO you must be aware of before you decided on investing in the fund.

1. The fund opens for subscription on July 12, 2023 and the NFO subscription will close on July 26, 2023. It is an open ended fund that offers continuous purchase and redemption available at NAV linked prices.

    

2. Entry loads do not exist in India, but if the fund is redeemed or switched within 90 days from the date of allotment, it will attract an exit load of 0.50%. There will be no exit load beyond that.

    

3. The minimum investment in the Kotak Quant Fund NFO will be Rs5,000 in the NFO and in multiples of Rs1 thereafter. 

    

4. The fund offers Regular and Direct plans for the investors. In addition, investors can either choose the Growth option or the IDCW (income distribution cum capital withdrawal) option, based on what suits their needs.

    

5. How will the fund be benchmarked? It will be benchmarked Nifty 200 TRI index (total returns index). Harish Krishan, who was formerly managing the Kotak offshore funds out of Singapore and Dubai, will be the fund manager for the Kotak Quant Fund.

The Kotak Quant Fund NFO is an opportunity for investors to invest in a fund based on black-box models. Globally, that is a growing field, although it is yet to catch on in India. The quant fund comes with its share of excitement but also comes with its share of risks for investors. The investor has to make a prudent choice.