The way the financial investment domain is adapting to the latest technological advancements and relying on automation to use robo-advisory platforms and online apps or tools to serve investors better shows that it is evolving.

Using artificial intelligence to select equity stocks is under consideration along with the implementation of Quantitative models because of the specific framework involved is another step of technological advancement.

Tata Mutual Fund has launched the Tata Quant Fund which will select stocks in its portfolio based on quantitative decision-making framework.

The fund house is of the view that Quant fund has the following advantages.

• Leverage the strength of Artificial Intelligence (AI) & Machine Learning (ML) for investment strategy formulation
• Ability to handle massive computational intensity for stock selection & allocation
• Reduce human bias, error and emotion
• Restrict choice of stocks based on the model (algorithm)
• Consistency in strategy
• Additional investment option for investors
• Disciplined investment process, offering superior risk control

What is a Quant fund?

A quant fund is a thematic /sectoral type of an open-ended equity mutual fund. It follows a specific approach of investing. Quant funds follow quantitative analysis to select stocks while constructing the portfolio which is based on several factors combined. Fund managers create a mathematical model that determines the fund’s investment.

Since there are a host of factors used in investing a quant fund, this fund uses a multifactor approach of investment. A quant-based strategy of investment is between actively managed funds and index funds; as the investment decisions are determined by a scientific model than by human judgment created by the fund managers.

So, combining machine and human ability with minimum human intervention, Tata Quant Fund is designed to seek benchmark-beating returns for an investor who wants to invest in a well-diversified fund across market caps and sector agnostic and have an investment time horizon of seven years or more.

Table 1: Details of Tata Quant Fund

(Source: Scheme Information Document)

How will the scheme allocate its assets?

Under normal circumstances, the scheme’s asset allocation will be as under:

Table 2: Tata Quant Fund’s Asset Allocation

Instruments	Indicative allocation (% of total assets)		Risk Profile
	Minimum	Maximum	High/Medium/Low
Equity & Equity related instruments^	80	100	Medium to High
Debt & Money Market instruments*	0	20	Low
Units issued by REITs and InvITs	0	20	Medium to High

^ The Scheme will invest at least 80% in equity and equity-related instruments selected based on a quantitative model
*The Scheme shall not invest in foreign securitized debt and credit default swaps.
Investment in a domestic securitized debt shall be restricted to 10% of the net assets of the scheme

(Source: Scheme Information Document)

What will the Investment Strategy be?

The investment strategy of Tata Quant Fund would be to achieve the investment objective by constructing a portfolio of equity and equity-linked instruments. The strategy would be to construct a diversified portfolio across market capitalization and sectors.

The Quant model-based factor strategy is expected to provide combined benefits of active and rule-based systematic investments by minimizing the influence of human emotions and biases in decision-making, increasing discipline, and leverage the computation power of machines for operational efficiency.

The investment strategy of this fund is to use proprietary in-house Quant Models for

• Optimal factor-based portfolio construction and
• Identify hedge positions (partial of full) or reduce net long equity exposure to improve performance consistency.

The Quant Model will use parameters that include:

• Equity stocks selection will be predominantly from a universe of S&P BSE 200 or stocks which are part of Equity Derivative segment
• Fundamental parameters that are also used in Factor Models like
  • Return on Equity & capital employed
  • Earnings, dividend and leverage
• Macroeconomic parameters related to
  • GDP & inflation
  • Interest rates
  • Currency & commodity, etc.
• Index movements

The above list is illustrative and may include additional parameters or exclude some parameters with the change in the market conditions or economic factors/situations.

The portfolio will be re-balanced at a monthly frequency; however, the fund manager may alter this frequency based on the market conditions.

Equity positions would have to built-up gradually and sold off gradually. This would necessarily entail having large cash position before the portfolio is fully invested and during periods when equity positions are being sold off to book profits/losses or to meet redemption needs. However, always the portfolio will adhere to the overall investment objectives of the Scheme.

The scheme may also use various derivatives and hedging products from time to time, as would be available and permitted by SEBI, to protect the value of the portfolio and enhance unitholders’ interest.

Further, the scheme may invest in other schemes managed by the AMC or in the schemes of any other Mutual Funds in terms of the prevailing regulations. As per the Regulations, no investment management fees will be charged for such investments.

Who will manage Tata Quant Fund?

Tata Quant Fund will be managed by Mr Sailesh Jain. He has done his MBA in Finance and has been a part of Tata Asset Management Ltd since November 2018 as a fund manager. Preceding to it he has been with IDFC Securities Ltd., Quant Broking Pvt. Ltd. and IIFL (India Infoline).

Currently, at the fund house, he manages Tata Digital India Fund, Tata Equity Savings Fund (Equity Portfolio), Tata India Pharma and Healthcare Fund, Tata Resources and Energy Fund, Tata Arbitrage Fund, Tata Nifty Exchange Traded Fund, Tata Balanced Advantage Fund (hedged equity portfolio), and Tata Nifty Private Bank Exchange traded fund.

The Outlook for Tata Quant Fund

As mentioned earlier to achieve the objective of the Tata Quant Fund, a quant model-based will use an internally developed machine learning-based model to make investment decisions. The Machine Learning Models work on two broad categories of input variables:

1. Macro-Economic: Domestic Macroeconomic Data, Global Equity Indices, Dispersion between expected and real Index earnings, Yield Spreads, Credit Spread, India Volatility index etc.
2. Security Performance Parameters: Price momentum, Jensen Alpha, P/E, P/B, ROCE, D/E, D/Y, ROE, EPS.

Diagram 1: Tata Quant Fund’s Machine Learning Model

(Source: Tata Quant Fund’s presentation)

This machine-learning algorithm is used to predict upturn or downturn in the forthcoming month. The variables on which the algorithm is based includes, among other factors, the following:

• Historic momentum for each factor model & absolute returns
• Economic parameters (domestic & international)

Diagram 2: Indicative combinations of factors to create a portfolio

(Source: Tata Quant Fund’s presentation)

Despite the rigorous research and periodic rebalance based on latest economic & market information to construct the portfolio, it remains to be seen how it is being constructed. In an environment where the near-term sentiments in equity markets will be driven by macroeconomic conditions, on-going geopolitical tensions, domestic political developments, along with all eyes on the upcoming budget, the markets are expected to remain highly volatile.

Hence, the construction of the portfolio would be a challenge for the fund manager and his team to spot opportunities in the current environment and the risk management measures they adopt.

PersonalFN believes that the current time does provide an opportunity to do some value buying to the fund managers. However, amidst the extreme turbulence, constructing the portfolio would not be easy and may inflict extremely-high-risk. Therefore, although there may be good opportunities in the long run, the risk could be very high as well.

Tata Quant Fund is a thematic fund that focuses on a fixed set of theme/sectors, due to which the underlying risk potential of such funds is high. What if the underlying sector/theme does not play out for a long time or does not meet the expectations of the fund manager and the investors to provide optimal returns? Therefore, sector and thematic funds are not meant for everyone.

Thus, before investing in the Tata Quant Fund, it would be wise to assess your own risk appetite and investment horizon.

[Read: 5 Basic Steps To Pick The Best Mutual Funds To Invest For The Long Term]

This article first appeared on PersonalFN here