Will Quant front-running case impact Indian mutual funds industry? Unlikely, say experts

Impact of SEBI's investigation of quant Mutual Fund on the Indian mutual funds industry

At a time when mutual funds are increasingly the pick for retail investors, the question is: Will the latest flap in the industry harm it critically?

The question arises from the Securities and Exchange Board of India (SEBI) conducting search and seizure operations at Quant Mutual Fund's premises (MF) earlier this month.

Also read: A Moneycontrol exclusive: SEBI suspects front-running in Sandeep Tandon's quant Mutual Fund

Innovation vs big brands

Seven fund houses were launched in the last three years, each with a unique strategy. To be fair, even Quant MF, a tiny and upcoming—if not brand new—fund house had its own unique strategy of stock-picking, something that appears to have worked, which partly explains its stupendous returns. As of May 2024, Quant MF’s assets under management (AUM) stood at Rs 80,470 crore, up from just Rs 256 crore in January 2020, a compounded rise of 270 percent, the highest in the industry over this period. That was, of course, before the SEBI action.

Industry insiders say that Quant's woes are not just a small fund house problem. “I don’t think you could say this might impact the perception of small fund houses. Front-running can happen anywhere, even larger fund houses are prone to market abuses. Recent examples like Axis MF and HDFC MF more than a decade ago are evidence that front-running can happen even in larger fund houses,” said a fund chief who didn’t want to be named. All fund industry officials that Moneycontrol spoke with for this story requested anonymity.

Inflows chase performance, but…

Quant MF’s stupendous performance has also attracted a lot of investors who wish to invest directly with the fund house. Nearly 53 percent of its assets lie in direct plans, as per data from ACE MF, which tracks the industry. “Typically, the sort of investors who invest in Quant MF like to see high to very high performance; they tend to get more attracted to direct equities and futures and options, in my opinion,” said the CEO of another fund house.

A large distributor, who is among the fund house’s top distributors, strongly disagreed, saying that Quant MF earned investors’ respect. “Tandon (referring to founder Sandeep Tandon), and his team have shown that without a branch network, without a large sales and marketing team, a fund house can show performance and attract investors,” this distributor told Moneycontrol.

There’s no denying its strong inflows. Quant Active Fund, a multicap scheme, garnered 13 percent of the category’s inflows between January 2013 and May 2024, as per a Morningstar analysis. Only three of the 26 schemes in the category did better than that, two of them by less than a percentage point. Note that scheme-level inflow and outflow numbers are not publicly available; Morningstar, a globally renowned mutual fund and equity research firm, derives this number (an approximation) by deducting market gains from the change in a scheme’s corpus. Quant Small Cap Fund, its largest scheme with a corpus of Rs 21,243 crore, garnered nearly 70 percent of all small-cap inflows so far this year. A caveat here: Morningstar doesn’t approximate inflows / outflows of schemes where inflows are restricted and hence hasn’t derived these numbers for SBI Small Cap and Nippon India Small Cap, two of the largest small-cap funds in the industry that have restricted inflows. But the sheer rise in the Quant MF’s overall AUM is testament to its inflows.

A large section of distributors and financial advisors that Moneycontrol spoke to said some Quant MF schemes were in demand by investors. But having a disproportionate proportion of assets in direct assets meant that a large section of the distribution fraternity has been slow in recommending the funds to their investors. One distributor told Moneycontrol that he had recently invested some money in quant MF purely based on performance, but is yet to recommend it to his investors, not until he has “tried it out completely”.

Relaxed sponsor rules

When a fund house is handling such large sums of money, it brings to fore the key man risk, despite a stellar track record. Tandon wears multiple hats. He is the fund house’s chief executive officer, chief investment officer, director on the asset management company's board as well as the fund manager, as per its Statement of Additional Information. The only other equity fund managers in the house are Ankit Pande, 37, with 10 years’ experience in Indian equities, and Vasav Sahgal, 28, with four years’ worth of experience in valuation analytics.

At a broader level though, SEBI has reduced the entry barriers in the Indian MF industry. In 2023, it had overhauled the sponsor and trustee requirement rules to foster innovation and to allow smaller and newer firms to set up a mutual fund house. If the sponsor didn’t have a track record in the financial services space (previously a mandatory requirement for all sponsors who wished to set up an AMC), or didn’t have a profit in each of the immediate five years (this was revised from the earlier requirement of profits in three of the immediate five years), sponsors could set up an AMC under the alternative criteria. Here, the AMCs must be capitalised with at least Rs 150 crore, of which Rs 100 crore is liquid net worth and locked in for five years.

To be sure, Quant Money Managers Ltd (the fund house or AMC) is owned by Quant Capital Finance and Investments Pvt Ltd (91 percent shareholding) and Tandon (9 percent). “Despite Tandon’s spectacular track record, there is a key man risk here,” said a top key official at a fund house.

What should Quant investors do?

Stay invested. There is no need to panic at the moment, at least until SEBI completes its investigation. But go slow on additional and incremental investments till the final verdict comes.