Quant MF-Sebi probe saga: Should investors continue SIP or exit its funds?

Quant Mutual Fund, a high-performing AMC in India, is under SEBI investigation for possible front-running. Should investors stay invested? Here is everything you need to know

A cloud of uncertainty hangs over Quant Mutual Fund, a high-growth asset management company (AMC), as the Securities and Exchange Board of India (Sebi) has launched an investigation into potential front-running activity.

Front-running is a deceptive practice where someone with advanced knowledge of upcoming trades by a mutual fund uses that information to make personal securities purchases beforehand. This allows them to profit from the anticipated price movement when the fund executes its actual trades. Essentially, the insider gains an unfair advantage at the expense of the fund's investors. 

This news has sent shockwaves through the investor community, particularly those with holdings in Quant's various mutual fund schemes.  Quant has become a prominent player in the Indian mutual fund industry within a short span of six years, boasting a significant asset base of Rs 84,000 crore, primarily invested in equities.  Many of these schemes have also delivered strong performance historically. However, the front-running allegations raise concerns about the integrity of these past returns and the potential impact on future performance.

Karthik Anand Vijay of Value Research explains the modus operandi: 

The dealer learns that a fund house is set to buy shares of Company A. He/she will buy Company A shares at (say) Rs 100 in their personal account or affiliate's account(s). At a later date, the dealer will buy the shares of Company A on behalf of the fund house. As the share price rises and goes up to (let's say) Rs 110, the dealer will make a cool and easy 10 per cent profit. If the said dealer drives up the share price before investing on the fund house's behalf, then you stand to lose as an investor in the mutual fund.

The market has seen instances of front-running earlier as well. In 2020, SEBI imposed fines on several entities for front-running trades executed by HDFC AMC. Axis Mutual Fund also faced a similar situation in 2022, which led to significant outflows and a drop in stock prices of companies that were in question.

Investors in Quant's mutual fund schemes are understandably worried about the investigation's potential impact on their investments.

Should investors exit Quant funds?

Investment recommendation platform Prime Investor has advised investors to exit Quant Mutual Funds in light of front-running allegations.

Prime Investor in their note said that repercussions of these allegations on Quant AMC are yet to be ascertained. However, the company could potentially experience redemption pressure and a possible drop in the price of portfolio stocks allegedly used for front-running.

We are now uniformly issuing an exit call on all the equity and hybrid funds of Quant AMC, whatever be their call earlier," said Prime Investor in a note to investors.

"For an AMC like Quant, with a good proportion of mid- and small-cap stocks or low float stocks, high redemption pressure can start impacting NAV and cause damage to the remaining investors," the note said. "While this call may seem rather hurried; however, simple news like this, the actual impact of such front-running notwithstanding, can cause enough damage to sentiment in the AMC and impact redemptions," the investment advisor said.

PrimeInvestor further said an exit is necessary in Quant funds on the grounds that many of their stocks are momentum plays, and sudden redemptions and disruptions in inflows can have a greater impact on such strategies.

Value Research on the other hand has asked investors to wait and watch right now.

" SEBI should investigate and take appropriate action against those who engage in front-running and those who should have prevented it but failed to do so. They should also claw back any illicit profits and add them to investors' assets.

However, all things considered, and drawing a parallel with past cases, there is little logic in investors getting out of Quant funds based on what we know so far. It's possible that the circumstances may be worse than they look right now, but wait and watch is the right policy," said Dhirendra Kumar of Value Research. 

Quant may witness some outflows in the near term

"We do not rule out a sentimental knee-jerk reaction to the recent SEBI enquiry against Quant MF for front running allegations and may witness some outflows in the near term. However, we do not foresee a major shift of money away from the fund house as the company has delivered superior risk-adjusted returns in the past across various market cycles by deploying a combination multi-faceted research and technology. With an enquiry still underway and based on the ramifications of the recent Axis MF fiasco, we anticipate the company to come out of the woods and would not be surprised to see further growth in its AUM going ahead. We, therefore, advise investors to stay invested in the funds managed by the fund house and wait for further clarity to emerge on the allegations levelled against the company," said Manish Chowdhury, Head of Research, StoxBox. 

Continue SIPs but wait for lump sum investments in Quant funds

"At the moment we will like to give benefit of the doubt to the Quant and would advise investors to stay put. We do not see any major impact on the performance of the funds. We all know how good they have been in their performance. Massive redemptions across the board should be clearly avoided till absolute clarity is received. Investors should continue their SIP’s in the Quant funds but wait for lump some investments in their schemes till the enquiry is completed. There is no need to panic as we have full confidence in the regulator. We do not foresee any major negative impact on stocks in their various schemes," said Gaurav Goel, a Sebi registered investment advisor. 

No more fresh allocation towards Quant funds

"As the news of Sebi probing Quant MF for front running emerged, we could see some redemption pressure on the fund house level, negatively impacting their Scheme's returns. There might be more selling pressure in mid- and small stocks and schemes that Quant holds if SEBI finds the front running, and one can expect some underperformance in their funds in the near term. As we advance, we will track NAVs, inflows, outflows, and stock holdings for the upcoming weeks, before  taking a decision on what is to be done. However, we will not be allocating any fresh investment towards the AMC," said Dilshad Billimoria, a Sebi-registered investment advisor. 

Other experts Business Standard spoke to said the Sebi investigation shouldn't directly impact the Net Asset Value (NAV) of Quant's funds. The NAV primarily reflects the performance of the stocks the fund holds, not external events like SEBI investigations. However, while the investigation may not directly affect NAV, it could potentially damage investor confidence in Quant, impacting future inflows and ultimately affecting the fund's performance.