QUANT FUNDS: MASTERING THE MARKET WITH MATH

By Karthik Kumar,

Quantitative strategies that rely on mathematical models and algorithms to make investment decisions have gained immense popularity in the West. That trend is also picking up in our markets as is evident from the wave of quant fund launches over the last few years.

Given the structural explosion of data and availability of cheap computing power, fund houses are launching fundamentally grounded strategies that leverage the power of data, ruled based process and mathematical / statistical approach to identify investment opportunities across broad range of securities.

There is a common misconception that all quant funds are similar in nature. The truth, however, is that no two quant funds are same, not even close. They can differ significantly in their strategies, objectives and methodologies.

Defining style

One of the primary elements that distinguishes two quant funds is the underlying style they wish to adopt. Just like mutual fund houses tend to have a preference for styles like value, growth, quality, etc., a quant fund may choose to adopt any of the styles or a combination of these as the basic building block of the model and hence the portfolio.

Further, the definition of style is also open to interpretation. For instance, a value portfolio can be constructed using only one measure like price-to-book. However, one could also use other valuation measures like price-to-earnings in conjunction with price-to-book to get a more robust and reliable view of stocks’ value.

Further, while at first glance, financial ratios may seem fairly easy to calculate, there is a fair bit of decision making that goes into it — ranging from data sources, financial ratio definitions to its interpretation. For example, should you compare the valuations of a consumer stock with a utilities stock or should it only be compared to stocks within its sector? While there are no easy answers, these decisions need to be made consciously as they have repercussions on the portfolio and subsequently, the potential returns.

Portfolio construction & risk management

A quant fund’s systematic approach to portfolio construction eliminates subjectivity and incorporates risk management in the stock selection process. Once the style and the requisite factors have been determined, the fund manager decides on the stocks to add to the portfolio based on these mathematical models and risk parameters.

Risk measures to consider in this regard can include the number of stocks to hold, maximum and minimum stock / sector weight limits, portfolio volatility, Futures and Options exposure, if any, and turnover considerations. These parameters will influence portfolio returns and performance across various market conditions, shaping the overall behaviour of the portfolio.

Quantitative approach to investing follows a rule based, systematic method that can produce long-term positive returns across market and economic cycles. When considering investments in quant funds, investors must carefully evaluate points highlighted above in addition to traditional measures like risk, drawdown, performance, etc,. to ensure alignment with their financial objectives and risk tolerance.

Quantitative funds can be an effective tool for portfolio diversification and a new way to capture emerging markets trends at a stock or thematic level. However, informed decision making is needed to navigate the diverse landscape of quant strategies.

(The writer is fund manager, Axis Mutual Fund)

2024-02-02T23:19:58Z dg43tfdfdgfd