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Quant Funds If science fiction like "The Matrix" and "2001: A Space Odyssey" are any indication, homo sapiens are not comfortable with the idea of artificial intelligence controlling their destiny. So why ever rely on a computer model to manage your investments? Because, in the real world, it seems to pay off… Meet your new Fund Manager: a Computer! …many mutual funds that make their trades based on the advice of a proprietary computer model, known as quantitative or quant funds, have outperformed their benchmarks. The Black Box A quant fund is an investment fund where the managers build computer-based models to determine whether or not an investment proposition is warranted. The models have been called black boxes, while the brains that built the models have often been dubbed "quants", “quant jockeys” or "rocket scientists," with “financial engineers“ being the latest preferred euphemism. It is not for nothing that they are called “black-box” funds — opaque to outsiders, the boxes contain investment magic understood by only the wizards who conjured it up. The Magic unleashed… Inside these black boxes are what are called factor models. Quant models use a variety of techniques such as fuzzy logic, neural networks, genetic algorithms, Markov models, clustering techniques etc. The process begins with a fairly straightforward stock screen that acts as a search engine. The fund manager programs it to look for stocks with variables that matter say, high-percentage growth. Once the stock screen culls out a long list of stocks, the quantitative model kicks in, measuring such things as how those stocks performed assuming an estimated economic growth rate, interest rate etc. These models are very early on their initial buys and very late on their sells. This can be adjusted appropriately by…the inevitable human touch. The first Quant Fund in India - Lotus India AGILE Fund Quantitative techniques emerged in the early 1970s in the United States and the Vanguard Group created the first Quant fund in 1985. Quant funds have slowly reach Indian shores as Lotus India Mutual Fund launched India’s first Quant fund called Lotus India AGILE Fund in November 2007. An ELSS Fund by the same name is currently open. AGILE means Alpha Generated from Industry Leaders Fund. Alpha is the measure of a fund`s performance with respect to the performance of the index against which the fund is benchmarked (the S&P CNX Nifty in this case). The portfolio of the fund will comprise of stocks that have at least a one-year price history, market capitalisation and floating stock not less than that of any other stock in the benchmark index and industry representation in the benchmark index. The fund will invest in 11 stocks determined by a mathematical model and the portfolio will be reviewed and reset every month. Out of the total corpus, 9 per cent will be invested in each of the 11 stocks and one per cent will be kept in money market instruments. This fund was back-tested down to 11.5 years and it has performed extremely well in bear markets (losing less) as well as in bull markets (gaining more). The intention of the fund is to generate alpha or excess returns over significantly long time periods. Unlike its US counterparts (where leverage seems to be ripping quant funds apart), leverage is conspicuous by its absence in this fund. AGILE is not a replacement to existing funds. It is an additional asset allocation option to de-risk your portfolio. An ode to Quants If computers can beat world champion chess players, shouldn't they be able to beat the traders on Dalal Street? That is the rationale behind quant funds. · Human emotion and behavior are too often the enemy of sound investment hygiene. Computers are not swayed by emotion and they obviously react much faster than a person ever could. · Quantitative models can examine a much larger universe of stocks than human analysts at great speed, thereby, ensuring that odds ultimately work in their favour.
· Most models keep sector and equity picks within the benchmark attributes they are built around, thereby, incorporating superior risk control. Recent research by Dresdner Kleinwort’s behavioural strategist James Montier demonstrates that where quant models and humans had the same information set, the models performed much better – a hit ratio of 73.2% as against 66.5%. The evidence is clear: quant models usually provide a ceiling from which we detract performance rather than a floor on which we can build performance. The woes of Quants So why don’t we see more quant funds in the market? The answers unfold…
The huge growth in the size of the Indian markets, the availability of computing prowess at low costs coupled with the penetration of Internet trading, formalisation of quant investing arresting the initial inertia and the robust and dynamic models with built-in risk control and exceptional returns seem to favour Quant funds. Their success in India remains to be seen…Nevertheless, the launch of the Lotus India AGILE Fund heralds a new era of machines meticulously managing money under the able tutelage of his majesty, MAN, of course! |
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n Mrs. Lalitha Muthu e-mail : lalitha_ppm@yahoo.com |
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