Quant funds remove human bias but may not outperform during bull run

If you are looking to invest in mutual funds which hold good quality stocks and minimises the risk of losses in falling markets, Quant Funds could be a good option

When a mutual fund (MF) investor puts money in a scheme, he is always betting on the fund manager’s stock-picking ability. But fund houses are beginning to experiment with schemes that work without a fund manager — quant funds. 

Driven by the use of artificial intelligence (AI) and Big Data, the first fund house to launch this scheme was Reliance MF over a decade back. But it is only last month that DSP MF launched its scheme, and now ICICI Prudential is also planning to launch a scheme in this category soon.

In these schemes, stocks are automatically selected through AI, based on various predefined parameters and data points. For stock selection, the asset management companies consider several factors like price-to-earnings ratio, valuations and others. But can these funds generate higher returns than funds managed actively by fund managers?

For one, such schemes do not chase the next multibagger — both a benefit and a loss for the investor because such stocks in the portfolio have the potential to earn significant returns or give immense grief. The data-driven approach helps remove the personal biases that might creep into a fund manager’s decision. 

“Quant-based funds try to eliminate biases and replace the investment decisions based on predefined investment rules, thereby bringing consistency in investment decisions,” says Suraj Kaeley, senior advisor, FundsIndia.

However, he points out, on the flip side, the rules are derived on past data, and hence, the same may not apply in the future. Several strategies work well when back-tested but fail miserably in the future. 

“The elimination of human bias cannot alone ensure top performance by quant funds. The success of any quant fund will depend on the efficacy of the underlying quantitative model in the contemporary market condition. Being back-tested on historical models, these funds may find it difficult to deal with unexpected market events. Quant funds are most likely to underperform active funds during market rallies driven by sentiment or euphoria, not backed by strong fundamentals,” says Naveen Kukreja, chief executive officer and co-founder, Paisabazaar.com.

Moreover, there is no guarantee that they have handled volatility better either. “There is no guarantee that the quant fund would be less volatile just because it is rule-based. It remains to be seen if quant-based investing will replace the skills of a fund manager,” says Kaeley.

If you are looking at investing in MFs which hold good quality stocks and minimise the risk of losses in falling markets, quant funds could be a good option, provided you stick with them over the long term. “Investors should not expect benchmark-beating performances during bullish market, driven by strong market sentiment or euphoria,” says Kukreja. 

Investors should understand the product before investing. Investors can benefit from a rule-based approach provided they know the rules and the limitations that come with it. Ideally, investors should start by testing the waters with a small number of investments, and as they understand these products, they can increase their allocation in this category.