February 03, 2016

Active Passive Twist

There is a certain equity fund managed by one of the biggest fund houses that is pitched as “an actively managed investment fund that approaches stock selection process based on a proprietary system-based model”.  For the purpose of further reference, let me just call it “Amazing Quant Fund”.

The fund house claims that this fund provides investors with “a twin advantage of stock selection process based on quantitative model and the Fund Manager’s expertise leading to active fund management”.  It further describes its model as one in which they would “shortlist 15-20 CNX Nifty stocks through a screening mechanism at pre-determined intervals, i.e. on weekly basis” based on “parameters like valuation, earnings, price, momentum & quality, thus, giving a leverage to diversify risks and returns in such a volatile situation”.

While the grammar in that description and the choice of words does perplex me, the reason I spotlight this fund is because its origins and performance make for an interesting tale.  It came into being in April 2008, in the early days of the market crash, as a replacement for an index fund that had been in existence since 2005.  More specifically, the fund house changed the objective of the index fund and renamed the fund.  At first, the decision appeared to be justified.  As the markets fell further, Amazing Quant Fund fell slightly less than the NSE-50.  When the markets recovered, this fund outperformed the index.

But then, in September 2010, the fund house decided to re-launch an index fund, identical to the one they previously had.  Within months of this launch, the returns of Amazing Quant Fund started trailing those of the index fund.  According to Value Research, such was its performance that from 2011 to 2015, in each calendar year, Amazing Quant Fund ended up giving lesser returns than the index fund, irrespective of markets being up or down. In the brief period of this year, too, that trend continues.

To be fair, the difference in returns can be explained by the difference in their expense ratios.  Even so, there is little or no value being added by their so-called model and/or the fund manager’s expertise.  But what intrigues me most is this: despite the tendency of advisors and investors to allocate money based on recent past performance, Amazing Quant Fund has an AUM in excess of 1000 crore whereas the index fund has an AUM of less than 100 crore.  Maybe they cannot see the facts for what they are.  Or maybe the high expense ratio (and hence commissions) has something to do with that.

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