Sunday, November 18, 2007

NOW, COMPUTER IS YOUR FUND MANAGER

Lotus MF launches India’s first quant mutual fund scheme

If you do not trust the abilities of a fund manager to consistently pick winning stocks, perhaps you would trust a computer to do the same. That’s what quantitative – or quant funds worldwide do – instead of allowing their fund managers to do stock-picking, they pick stocks based on a quantitative analysis by computer-based models. This is one of the growing breed of mutual funds (MF); in the US, the assets under management of quant funds are at $1.9 billion in 2007, up from $0.2 billion in 2003. Expect quant funds to slowly reach Indian shores as Lotus India MF has launched India’s first quant fund, called Lotus India Agile Fund (LIAF).

The formula
LIAF is an equity fund that will be passively managed and run purely on the basis of a mathematical formula devised by the fund house. For starters, it will consider only those scrips with a market capitalisation and floating stock equivalent to or more than the least market capitalisation and floating stock of Nifty index, respectively. Further, scrips must have a price history of at least one year and should belong to a sector whose scrips are present in Nifty.

Based on the stocks that the above filer will throw up, LIAF will pick up the top 11 stocks after running a formula. It will invest nine per cent in all these 11 scrips, in equal proportion, and the remaining one per cent in cash. In other words, LIAF will have only 11 scrips. As LIAF is an open-ended fund, any subsequent inflows will be equally distributed into these 11 stocks. LIAF will run the formula at the end of every month and rebalance its portfolio subsequently.

If the formula run in a particular month throws up a fresh list of stocks, different from the ones LIAF presently folds, LIAF will exit all its existing holdings and invest in the fresh list so generated. Lotus MF did not reveal the formula that would help pick these 11 stocks. “Revealing the formula would give away the scheme’s way of management, and that any other fund house could easily duplicate the scheme”, says Rajiv Shastri, Head-business development and strategic initiatives, Lotus MF.

Should you invest?
Unlike diversified equity funds, quant funds are passive. However, they are more active than index funds and try and generate returns in access of market returns by means of devising a smart formula that the fund hopes would work across market conditions. And therein lays the trick. Note that although the formulae are computer-based, they are devised by the fund management team and therefore do not completely eliminate the human element.

So, how do you analyse a quant scheme’s worth when it does not have a track record? Lotus back-tested this formula and ran a simulated scheme (based on the same selection criteria) from 1998 up to date. LIAF returned 26.31 per cent one-year rolling returns over a period of six years, as against Nifty’s 11.09 per cent, for the period ending September 30. It replicated its success over Nifty during the 2000 stock market crash and the subsequent lean period as well.

Having tasted success for the past 10 years gives us confidence that LIAF should do well over a long time. Invest.

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