What Are Quant-based Funds and Why Should You Consider Them?
Of late, investors are increasingly hearing about quant funds (short for quantitative funds) as a new approach to investing. These funds use computer models and data analysis to make investment decisions, rather than relying solely on a human fund manager’s intuition. In India, traditional active stock picking has long dominated, but quant funds have begun gaining traction in recent years.
But what are quant-based funds? How do they work, and what should you consider before investing in them? Read on to know more.
Meaning of Quant Funds
A quant fund is an investment fund (often a mutual fund or portfolio) where the investment decisions are guided by quantitative models, essentially, a set of rules or an algorithm. The fund manager doesn’t pick stocks based on gut feeling or just fundamental research; instead, they follow a predefined systematic strategy. In a way, quant funds are a hybrid of active and passive investing, meaning that the fund is actively managed, but the model’s rules constrain the manager’s actions.
The rules might be based on financial ratios, price trends, or other measurable criteria. As Sandeep Tyagi, Chairman & MD at quant-based investment management firm Estee Capital, recently explained, “In quant investing, what is true is the method and the system I’m following today is the method and the system I’m going to follow tomorrow. So I have a systematic research-based methodology which is well documented, followed down to the letter and applied period after period in a consistent way.“
Mr Tyagi spoke on the occasion of Gulaq, Estee’s investment arm, completing five years on the smallcase platform. In this special episode, he discussed Gulaq’s journey so far and what the future holds for quant investing in India.
Catch the full video here:
In India, quant funds are a relatively new category. The first quantitative (quant) mutual fund in India was the Nippon India Quant Fund, formerly known as the Reliance Quant Fund, launched in 2008. The idea behind introducing quant funds was to eliminate human biases in investing by using models. However, these models are often proprietary (secret sauces of the fund houses), which means the exact models may not be fully disclosed to the public.
Key Features of Quant Funds
Data-driven and Algorithmic: Decisions are based on mathematical models and algorithms that process vast amounts of market data
Objective & Emotion-free: Because of the rule-based approach, quant funds minimise human bias. The model executes the same way regardless of fear or greed in the market, so the strategy stays disciplined.
Systematic and Consistent: Quant funds follow a systematic process every time. If the model says “buy X, sell Y,” the fund will do that consistently.
Backtested Strategies: Models are tested on historical data to assess past performance before real-time application.
Uses Multiple Factors: From technical indicators (such as momentum or volatility) to fundamentals (like P/E ratios, earnings growth, and quality metrics), and even macroeconomic signals, quantitative strategies can incorporate a wide range of factors.
Technology-driven: These funds use AI, machine learning, and automation to enhance model accuracy and execution speed.
How Quant Funds Work
The process of running a quant fund can be broken down into a few basic steps:
Designing the Model: The fund’s team of quantitative analysts (quants) first develops a model—a set of rules and formulas for selecting investments. This model is built by studying historical market patterns and identifying what factors might predict good performance. For instance, they might discover that stocks with lower P/E ratios and positive price momentum tend to outperform. These insights are encoded into the algorithm.
Screening the Stock Universe: The model is then applied to a broad universe of stocks (e.g., all stocks in the Nifty 500 index, Nifty 100 index). It screens and filters the companies based on the chosen criteria (say, low-volatility stocks, highly volatile stocks, companies, etc.)
Building the Portfolio: From the screened list, the model ranks the top opportunities and constructs an optimal portfolio. This could be, for example, the top 20-30 stocks that best fit the model’s criteria, possibly with weightages assigned to each. This model portfolio is the target mix that the fund will hold.
Periodic Rebalancing: Quant funds don’t trade based on impulse; they typically rebalance their portfolios on a set schedule, often monthly or quarterly. At each rebalancing point, the fund’s models use the latest available data to generate new recommendations.
However, changes are not made lightly. Since consistency is key, any model tweaks are usually tested thoroughly before implementation. The fund house may also provide updates or insights to investors about what the model is emphasising.
Benefits of Quant Funds
No Emotional Bias: Perhaps the biggest benefit is that quant funds remove human emotions from the decision-making. The algorithm doesn’t panic-sell in a crash or overpay in euphoria; it sticks to the data. This objectivity helps avoid common investor mistakes driven by fear or greed.
As Mr Tyagi puts it, “Quant investing shines when you do not make emotional decisions… [instead] you are driven by systematic, disciplined methods of investing”.
Data-backed Decisions: Every pick in a quant fund is backed by quantitative analysis and historical testing. It’s a more scientific approach, closer to math and statistics.
“A lot of people think that it’s a black box strategy… In quant investing, what is true is the method and the system… is well documented, followed down to the letter T and applied period after period in a consistent way,” highlights Mr Tyagi.
Speed and Efficiency: Quant funds can react quickly to market information. Since computers can scan markets in real-time and send orders automatically, they ensure fast execution of the strategy. In contrast, a traditional fund manager might take longer to research and decide on changes.
Risk Management and Diversification: Quant models often include risk controls by design. For instance, the algorithm might limit how much can be invested in a single stock or sector to avoid concentration risk, resulting in a well-diversified portfolio. Of course, they cannot eliminate risk, but they can try to control it in a methodical way.
Factors Influencing Quant Fund Performance
Like any investment, the performance of quant-based funds can vary. Here are some key factors that influence how well a quant fund does:
Market Conditions: Quant funds may gain in certain market environments and struggle in others. Therefore, the prevailing market regime – bullish, bearish, volatile, sideways – will impact a quant fund’s results. No single strategy wins in every environment.
Risk Management Practices: During market downturns, funds that have built-in safeguards (like cutting positions when volatility is too high, or diversifying across enough stocks) may mitigate losses.
Adaptability of the Model: Markets are dynamic, so a key factor is whether the quant model can adapt to change. If a fund’s algorithm is rigid and only suited for past conditions, it may falter when new patterns emerge. The best quant funds are those that can be tweaked or have adaptive mechanisms for evolving market trends.
Choice of Factors/Strategy: Different quant funds focus on different factors. So, the fund’s performance is influenced by how the chosen strategy aligns with current market trends.
Crowd Behaviour and Competition: As quant strategies become popular, many funds may end up chasing similar signals. If multiple quant funds are all buying the same “high score” stocks, those stock prices could be driven up quickly (reducing future returns), and if they all sell together, prices can drop fast. This is sometimes called crowding. So, a quant fund’s performance can be impacted by how many others are running similar algorithms.
What to Keep in Mind Before Investing in Quant Funds
If you are considering investing in a quant-based fund, here are a few tips and considerations to ensure it’s the right fit for you:
Understand the Strategy: Know the fund’s style, whether it is momentum, value, or multi-factor. Avoid what you don’t understand.
Match Your Risk Profile: Quant funds carry equity-like risks and may be volatile—especially if focused on small-caps.
Think Long Term: Stay invested for a couple of years to allow the model to perform across cycles.
“Performance chasing… ends up creating unnecessary cost and almost always is less advantageous to the investor than investing, picking your advisor and managers and sticking with the product for some period of time. We suggest at least 3 years but at least one year is required for any kind of performance to start showing in a measurable way,” says Mr Tyagi.
Don’t Time the Market: Invest when ready. Quant funds are built to weather various market phases over time.
Diversify Smartly: Use quant funds as part of a broader portfolio. Mix with other fund types.
Check AMC & Costs: Choose a trusted fund house with quant expertise and a reasonable expense ratio.
Conclusion
Quant-based funds offer a disciplined, systematic way to invest, free from emotional biases and human error. They can be considered by investors looking for consistency and transparency. However, they are not magic bullets. It’s important to do your homework: understand the fund’s premise, ensure it aligns with your goals, and be prepared for periods of underperformance.
As always, consider consulting with a financial advisor if you’re unsure, and remember that any investment should fit into your overall financial plan and risk appetite.
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