Are quant mutual funds a good way to diversify portfolio during market volatilities?

“Quantitative investment funds are frequently used to diversify portfolios because they can expose investors to a wide range of assets and industries and may produce returns that are not associated with those of more conventional asset classes like equities and bonds,” said Ram Kalyan Medury, Founder & CEO, Jama Wealth

How quant funds benefit a portfolio during volatile times

Sonam Srivastava, Founder at Wright Research, SEBI Registered Investment Advisor said quant funds can benefit a portfolio during volatile times in several ways:

Systematic approach

Quant funds use algorithms and data-driven strategies to make investment decisions, which can help reduce human emotion’s impact on investment decisions and provide a more systematic approach to managing risk.

Diversification

Quant funds often use a wide range of investment instruments and strategies, which can help to diversify a portfolio and reduce overall risk.

Low correlation

Quant funds may have a low correlation with other asset classes, meaning they may not move in the same direction as the overall market. This can provide an additional layer of protection during times of market volatility.

Tactical Nature

Quant funds can tactically shift allocation based on market direction. While they might have bet on growth stocks in the bull run, as the market shifts, they can shift the budgets to defensive stocks or value plays, thus retaining an edge.

Potential for outperformance

Quant funds can outperform traditional investment strategies during market stress or uncertainty, primarily due to their distinct mandate of maximising performance based on expected returns while reducing portfolio risk.

Vivek Sharma, director (strategy) and head of investments at Gulaq, a part of Estee Group said that neither quant funds nor discretionary can protect the losses from market volatility. But research shows that the correlation between quant and discretionary is low. So that tells us that investors would benefit from having both kinds of funds in their portfolios.

“The problem is not with the quant or discretionary style of investing, but it is with a concentration of methodology. Many quant funds have been relying on just one factor, mostly its momentum, and investors are very disappointed with how momentum quant funds have performed in 2022. On average, momentum funds would have lost money after counting fees, slippages, and other transaction costs,” said Vivek Sharma.

The best way to diversify is to select portfolios that are not focused on one factor but are multi-factor in nature, he added.

Risks associated with quant funds

Ram Kalyan Medury, Founder & CEO, Jama Wealth, SEBI Registered Investment Advisor said that there are the risks associated with quant funds:

Market risk

Like all investments, quant funds are subject to market fluctuations and may lose value due to changes in market conditions.

Liquidity risk

Some quant funds may invest in securities that are less liquid, which means they may be harder to sell or may be sold at a discount in times of market stress.

Model risk

Quant funds rely on mathematical models to identify and trade securities, and there is a risk that these models may be flawed or may not perform as expected in certain market conditions.

Data risk

Quant funds rely on large amounts of data to make investment decisions, and there is a risk that the data may be inaccurate or incomplete, which could lead to poor investment decisions.

Human error risk

Despite the use of algorithms and other quantitative methods, quant funds are still subject to the risk of human error, such as mistakes in data input or model development.

Systematic risk

Quant funds may be vulnerable to risks that affect the entire market, such as economic downturns or geopolitical events.

Quantitative funds can help diversify a portfolio and possibly lower risk, but they should be utilized as part of a comprehensive investing plan that takes into account an investor’s risk tolerance and financial objectives.