Mutual funds with a technology twist

Did you know that mutual funds can eliminate a fund manager’s intervention in managing the fund? Known as quant fund, it uses artificial intelligence (AI) to manage your money. “Conventional mutual funds are generally discretionary in nature where they try to use their skills and understanding and outperform the benchmark indices. In quant funds you create a system or process where a combination of factors that have historically worked in terms of rightfully picking the right securities,” said Ashutosh Bhargava, fund manager and head equity research, Reliance Nippon Life Asset Management Ltd.

These funds work on the basis of algorithms or programmed investment strategies. “There are very high level quant funds which use high level AI. However, smart beta strategies are more prevalent in the market. In smart beta strategies, you pick factors, put it in the system or model and then keep filtering companies which rank high on those factors,” added Bhargava. Not many have started using AI for fund management. “For regulatory reasons these funds fall under the thematic category. However, these funds can be of any market capitalisation and can pan across themes or sectors,” said Suraj Kaeley, senior advisor at FundsIndia.com, an online investment platform.

How does it work?

There are three to four factors such as value, growth, quality and momentum considered in a quant fund. “A typical quant fund diversifies within these styles rather than diversifying in terms of sectors and stocks. Stocks can also be filtered on the basis of their valuation, which is the price-to-earning ratio of a stock or on the basis of sentiments. Sentiment is measured on the basis of analyst ratings,” said Kaeley. So you could set a limit of a rating, say AA and put a condition that the stock of a company below AA rating needs to be removed so in accordance with the re-balancing schedule, modifications will be done.

Now for each style, certain factors are identified that have historically worked very well for the market. “One parameter (or factor) could be that the return on capital employed should not be more than 15%. In case the fund had chosen BSE500 as its benchmark, 350 companies will get filtered out because of this factor only,” said Kaeley. Now not all factors will outperform all the time. Here is where the minimal fund manager intervention comes in. “The fund manager will fuse them together and create a multi-factor system for stock-picking,” said Bhargava. “Rules are set for stock-picking, quantity and sell-off. So depending on the movement of the factor, the decision is triggered in the quant fund,” said Kaeley.

This rule-based investment can be done manually by a fund manager as well; “but every fund manager comes with a past success and expertise in certain values or factors and subsequently has a bias. A quant fund removes that bias and looks at all the factors. A fund manager is straight-jacketed to one style but quant funds are agnostic to factors or styles,” said Bhargava.

The expense ratio of quant funds lies between 1% and 1.25%. “Quant is not a proven fact yet. There is not much data. It is a new category building up, so over time we’ll know if they will do better than discretionary funds or not,” said Kaeley. The first fund which has been in the market for a decade has given 8.85% returns since its inception, according to Reliance Mutual Fund. Its benchmark S&P BSE 200 TRI has given 9.66% returns since the fund’s inception.

Should you consider it?

“These funds are low cost funds because there is minimal research required and almost everything is done on a system,” said Mukesh Dedhia, director at Mumbai-based Ghalla Bhansali Stock Brokers Private Ltd. When it comes to investing in quant funds, experts feel that they can certainly be a part of your portfolio. “It is becoming difficult for fund managers to beat the benchmark returns these days so a quant fund helps to evade that fund manager bias,” said Dedhia. According to Dedhia, quant funds can form 20 to 25% of your portfolio where there is an attempt to beat the benchmark, 25% in actively managed funds where fund managers beat benchmarks and 50% in passive funds which map the benchmarks. “For first time investors, it is not a strict no but if you have the understanding and knowledge for quant funds, you can have them in your portfolio,” said Dedhia. The investment horizon of a person investing in should be medium to long term.