SBI MF makes entry into quant fund category; should you invest?

SBI Quant Fund’s new fund offer (NFO) will close for subscription on December 18.

SBI Mutual Fund, the country's largest, has launched a quant fund that follows a multi-factor-based investing approach for picking stocks. The scheme will leverage rules-based and data-driven analysis to make investment decisions.

SBI Quant Fund, which opened for subscription on December 4, marks the entry of the fund house into the quant space.

What’s on offer?

Quant funds or quantitative mutual funds use quantitative analysis to make investment decisions. SBI Quant Fund utilises an in-house multi-factor model, incorporating factors such as momentum, value, quality and growth to optimise performance across various market cycles.

DP Singh, the deputy managing director and joint CEO of SBI Fund Management, the asset management company that runs SBI Mutual Fund, said, “By integrating established equity factors, each with distinct risk/return profiles, the fund aims to deliver optimal risk-adjusted returns and minimise behavioural biases."

In terms of stock selection, the investable universe of the fund is the top 200 companies by market capitalisation. Based on the framework, each of the 200 companies will be ranked based on momentum, quality, value and growth factors. A composite rank will then be arrived at in a weighted way between 1 and 200, with 1 being the best.

Also read | Quant mutual funds: Decoding the math behind algorithm-driven schemes

Under the momentum metric, the fund will look at the near-term and medium-term stock performance. For value, valuation parameters like trailing and forward valuations, dividend yield and enterprise value to sales (EV/sales) will be considered. In quality, fundamental ratios such as return on equity and debt to equity, and then sustainability of earnings will be used. Growth will take trailing earnings and trailing revenue growth into consideration, as also earnings forecasts as well predicted upgrades and downgrades.

Stocks with higher liquidity will have a higher weight and, as a corollary, less liquid stocks will be assigned a lower weight in the fund.

The fund also has a mandate to invest in overseas securities, but will look to avoid this asset class as of now.

“We wanted to go for a multi-factor framework because it will ensure that there is diversification and we are able to kind of capture different factors based on market cycles. This will also help us in reducing drawdowns of the framework and, hence, get a better risk-adjusted return,” said Sukanya Ghosh, fund manager, SBI Quant Fund.

What works?

The investment strategy of SBI Quant Fund will be dynamic as the scheme will look at the performance of all the four factors, and then increase or decrease the weight based on the factor that is performing well.

Also read | Multi-factor investing can help reduce drawdowns, deliver better risk-adjusted returns: Sukanya Ghosh

The framework has also set extreme limits for outperformance or underperformance of a particular factor. Whenever this upper or lower band is hit, the framework goes back to an equal weight before, after a review of the monthly performance, it is increased.

Because of the dynamic allocation of the factors, the model can recover faster as it can quickly pick up whichever factor is working better.

What doesn’t work?

A quant fund's success hinges on the accuracy and reliability of its underlying models. If these models are flawed or based on incorrect assumptions, the fund can incur substantial losses. For instance, the covid-19 pandemic exposed the limitations of many quant funds, as they struggled to adapt to unprecedented market conditions. It has been only in the past year or so that quant funds have begun to regain momentum.

If market dynamics shift dramatically in unexpected ways, the fund's performance may suffer.

What should investors do?

SBI Quant Fund builds in four factors and tries to bridge the gap between the active mutual fund and the passive index tracking space. This is suitable for investors who do not want the fund manager risk that is present in an active fund but at the same time do not want to completely migrate to the passive index tracking segment.

The multi-factor approach is among the faster-growing fund management models globally and investors around the world are allocating a higher proportion of incremental monies to such strategies.

There are 10 existing schemes in India in the active quant fund category, with different frameworks and models for stock selection and elimination. SBI Quant Fund offers a differentiated strategy in this space based on a robust model that has been tested by them and now will be tested in the markets once it is invested.

Also read | How to position your investments amid shifting growth-inflation dynamics

Some experts believe that multi-factor approach used by SBI Quant Fund is a good concept that has generally been known offer better risk-adjusted returns.

“The strategy optimises for various different factors and as there is a quant overlay, there are certain rules that would try to optimise for different factors at different points in the market cycle,” said Nirav Karkera, head of research at online trading platform Fisdom.

“One can wait and see how the quant model holds up across a couple of market cycles. One needs to see how adaptive the model is and if it is efficient enough to capture different phases of a market cycle. It (SBI Quant Fund) is a strong proposition and probably once it goes through a few cycles, one can have a higher degree of conviction and decide on allocating to it,” said Karkera.

SBI Quant Fund’s new fund offer will close for subscription on December 18.

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