What are Quant funds?
Quant funds are a type of mutual fund in which ever aspect from asset allocation to stock picking is dependent upon the predefined rules. The choice of the assets in the portfolio of the quant funds is based on the automated system and generally, the fund manager does not have any say in the process of decision making. The time of entry and exit is also decided by the automated system.
However, unlike the index funds, the quant funds involve fund managers in certain aspects. The fund managers are engaged in designing the model and monitoring the model which is deployed for making decisions regarding the portfolio. Mutual fund companies provide quant funds, and the quantitative models are also employed by the hedge fund managers for designing their portfolio.
Frequently Asked Questions (FAQs)
What is the significance of Quant funds?
The utilisation of the quantitative models while making portfolio related decisions and picking up the stocks results in the removal of the human interference, that is, bias is not present when stocks are chosen. For example, when a fund house employs a quantitative model which selects the stocks on the basis of the historical returns and the growth potential, then the model will not pick the stocks which are volatile or leveraged.
Moreover, the quant models are efficient in providing consistent results irrespective of the market conditions. When the market is dominated by the bearish trend, then the managers of the actively managed funds are forced to leave the market and re-think their investment strategy. However, the quant funds are managed in a passive manner and therefore the expenses are comparatively lower. Furthermore, the quant fund models have inbuilt checks on the sectors and stocks concentration.
What risks are associated with the quant funds?
Some academicians have presented the opinion that there is systematic risk is present in the quant funds. This makes quant funds unable to embrace the idea of letting a black box run its investments. The amount of the successful quant funds in the market is close to the amount of the unsuccessful ones. Moreover, when quant funds fail, they generally fail big.
Long term capital management was a famous quant hedge fund. The quant hedge fund gained its reputation as it was run by Robert C. Merton and Myron S. Scholes, respected economists who won two Nobel memorial prizes. In the 1990s, the fund was able to generate above-average returns and the team was able to attract capital investment from all ranges of investors. The reputation was gained because their strategy was not limited to exploiting inefficiencies, but the team was able to leverage their bets on market directions as they had easy access to capital.
The strategy was the actual reason for the collapse of the long-term capital management (LTCM). In the early 2000s, the company was dissolved and liquidated. The model was not efficient in taking into consideration the defaults done by the Russian Government in its own debts. One even triggered the events and chain reaction leading to the liquidation of the company.
The collapse of the company created havoc as it was heavily involved in a range of investment operations and its collapse dramatically affected the world market. At last, the Federal Reserve stepped in to control the damage created by the LTCM by supporting them.
The quant team is employed to constantly upgrade the models for predicting future events, but the aspect that the future can be predicted every minute should not be ignored. The quant funds can be overwhelmed in case the market and economy are undergoing more than average volatility. Moreover, the high turnover is accompanied by taxable events and high commissions.
A quant fund can be dangerous, especially when they are based on short term strategies or marketed as bear-proof. When the downturns are estimated by using derivatives and combined leverages can add risk.
What are the advantages of using quant funds?
The management style of the quant funds is different from the traditional fund managers; thus, they are classified as an alternative investment.
The cost of quant funds is low as portfolio managers and traditional analysts are not required for running them. The cost of trading is generally high because of the higher turnover of securities when compared with the actively managed funds. The offerings are more complex, and it is common that they target high fund entrance requirements or high-net-worth investors.
Investors consider quant funds as a highly technical and most innovative technology-based offering in the universe of investment. The quant fund encompasses an extensive thematic investment style and incorporates ground-breaking technologies.
The most successful quant funds continuously monitor the risk control because of their model’s characteristics. Most of the strategies begin with the benchmark or universe and sectors are used and industries are weighted in the models. This strategy allows the scope for diversification and the model is not compromised.
Why quant funds should be used?
The quant funds utilise algorithms and computer models to make predictions, therefore, the scope of human error is eliminated. Also, the cognitive and emotional biases are also eliminated.
Rule based investment techniques are employed for building the portfolio and shortlisting the stocks. The role of fund managers is limited as predetermined rules are sued for filtering and picking the stocks.
The models are reviewed on annual basis and tweaks are made. The most experienced investors and fund managers may fall prey to behavioural biases. Therefore, by creating quant fund models, an investor can create rules based on their fundamental and technical analysis.