Table Of Contents
What are Quant Funds?
Quant funds, also known as quantitative funds, are investment funds in which investment selection and related decisions are taken not with the help of human intellect and judgment but by analytical methods and advanced quantitative analysis. Since there is better availability of market data and the use of technology, investors prefer these funds more than ever.
Most quant fund companies, prefer using customized computers and technology as opposed to human interference as there are relatively lesser losses and risks. These algorithms do not consider opinions, judgments, or experience like human fund managers. Instead, they use quantitative analysis to pick the right stocks for the given time frame for the fund.
Table of contents
- Quantitative or quantitative investment funds are investments where investment selection and associated choices are made using advanced quantitative analysis rather than human intelligence and judgment.
- Investment in quantitative funds is essential because they reduce human biases and build a portfolio by adhering to the fundamental investment rules developed through market cycles, keeping things simple with minimal human interference.
- The fundamental investment rules are buying shares of reputable companies, avoiding overpaying for them, and being objective. The Quant Funds management carefully follows these rules.
Quant Funds Explained
Quant funds can be said to be a cross-breed of actively managed funds where a fund manager is always required to manage and index funds.
A fund manager is not required because index funds are market replicas.
Inactive funds, the fund manager, makes decisions about the timing of entry and exit of the investments, which is not so in the case of quant funds, wherein numerical methods, automated programs, and quantitative models are used to make decisions about the same. But that doesn’t mean a quant fund manager would have his hands off like an index manager. Here the fund manager would still be responsible for monitoring the quantitative/ arithmetical/ analytical model that comes up with the portfolio choice.
Incurring quant fund fees helps in portfolio diversification, but they cannot act as substitutes for regular actively traded funds. They can, as stated above, be considered funds that are midway between active and index funds. Though they are consistent, accurate, and fast, quant funds have a specialized place in the market, wherein it is necessary to be aware of the risks involved and the shortcomings attached.
Thus, quant-style investing should be mixed with other investment styles and strategies to obtain optimum returns and significant diversification.
Process
There are three steps or parts in the investment process of such funds. Let us understand them step-by-step through the detailed discussion below.
- Input System
In this step, inputs are provided to the system. Companies with good factors such as Dividend yield, earnings growth, return on equity, free cash flow yields (FCFY), etc., are chosen without bias, and the stocks of companies with high risk, high debts, stocks with high volatility, and inefficient capital allocation are eliminated. That means long-term denigrators of alpha are done away with, and durable sources of alpha are selected.
- Forecasting System
This step generates estimates and forecasts regarding the prices, risks, returns, and other factors. The evaluation of stocks is done at this stage.
- Portfolio Construction
After inputs are entered and forecasts are generated, a piece of portfolio advice is constructed. Each stock selected is given appropriate weights so that risk is reduced to an acceptably low level, and returns would be as desired. That means an optimum portfolio shall be constructed in this stage.
Examples
Let us understand how quant fund companies function with the help of a couple of examples. These examples will help us understand the intricacies of the concept in detail.
Example #1
DSP Quant Fund chooses stocks with high return potential and consistent earnings. Thus, while selecting stocks, the stocks of companies with high leverage and volatility would be eliminated.
The main motto of such funds is three folded:
- Buying good stocks at reasonable prices
- Holding such stocks for the right periods; and
- Remaining unbiased and not attaching emotion while investing.
The three-step process (input- forecasting- elimination) is followed above. In the first step, 80-100 companies are eliminated, and the stocks selected are tested for the factors such as growth, potential, returns, etc. Then weights are allocated so that there is proper diversification and also reduction of stock and sector concentration so that no stock can occupy more than 10% of the entire stock, and the weight of any sector shall also be around 10%, nothing much higher.
Example #2
While ace investors like Warren Buffet dismissed the advantages of investing in such funds, stating that an investor’s judgment about the business and tracking market emotions are still better ways of investing.
Out of the $25 trillion of US market capitalization, close to 35% of the funds are quant-driven. While actively managed funds are 15% of that amount, more than 50% of the funds are passively managed.
Similar trends have been found in other countries such as India where the Assets Under Management (AUM) were approximately Rs. 136 crores in 2018. Whereas, in 2022, that number jumped 180 times to Rs. 24,330 crores.
Importance
Let us understand the importance of investors incurring quant fund fees and how it helps asset management companies minimize their losses through the points below.
- Investing in Quant funds is essential because they reduce human biases and build a portfolio by adhering to the basic rules of investing tested over the market cycles, keeping it simple with minimal human interference.
- The basic rules of investing are buying stocks of good companies, not overpaying for the same, and being unbiased, which are the rules exactly followed by the Quant funds’ managers.
- Reliance on technology helps companies negate losses and risks to the bare minimum in comparison to the funds being managed by a human manager.
- It also becomes cost-efficient for both the companies and investors as the expense ratio is significantly lesser than actively managed conventional funds.
Advantages
Let us understand the advantages of quant fund companies curating such basket of shares with the help of technology and algorithm through the explanation below.
- Such types of investments would eliminate human bias and prejudice.
- The expenses are lower than those of active funds because a passive and consistent strategy would be followed.
- Usage of a model permits consistency in the investment strategies across all market conditions and, as a result, the risk control would be superior.
- The occurrence of errors would be reduced drastically.
- Human emotion, fatigue, etc. would not affect the investment as minimal human intervention exists.
- The decision-making process is fast and automated.
- Quant funds use the best machines, minds, and algorithms to make the most of the market inefficiencies.
- A well-supervised quant fund displays less volatility.
Disadvantages
Despite the various advantages mentioned above, there are a few factors from the other end of the spectrum that prove to be hassled for both asset management companies and investors alike. Let us understand the disadvantages of paying quant funds fees through the discussion below.
- Quant Funds rely on historical data for investment success.
- They have to be back tested several times and quite vigorously so until they work to meet the desired return.
- They rely on academic researchers’ advice rather than the guidance of skilled live traders, which may result in ambiguous solutions and investment decisions.
- The impact of unforeseen changes is not considered.
- There are a lot of assumptions taken, such as the stock prices, volume growth, and earnings ratio, to be historical, etc.
- Quant funds buy and sell stock only if they meet the predefined conditions. So even if a good stock has not met the volume criteria, the stock would not be bought.
Frequently Asked Questions (FAQs)
Quant Funds can outperform conventional investing strategies during market stress or uncertainty due to their unique mandate to maximize performance based on predicted returns while minimizing portfolio risk.
A Quant Fund is an investment fund whose stocks are picked based on numerical data from quantitative research.
The Quant Active Fund is an excellent investment option with an annualized return of around 42% over the past three years. In addition, it is a multi-cap category fund that offers diverse equity investment opportunities in one place, making it a convenient and promising choice for investors.
Quant funds might only be suitable for some investors, especially those who prefer a more hands-on and intuitive approach to investing. These funds require a good understanding of quantitative methods and a willingness to accept the risks associated with algorithm-driven strategies.
Recommended Articles
This has been a guide to what are Quant funds. Here we explain how Quant funds work, examples along with advantages, disadvantages, and importance. You can learn more about trading from the following articles –