Spam Prats Dec 12, 2009 No Comments
Fundamental analysis for stock picking is passe, quantitative investment strategy based on mathematical calculations is the in thing, say Prashant Mahesh & Nikhil Walavalkar.
Investors are familiar with stock selection strategies based on fundamentals. Most mutual funds and insurance companies follow fundamental analysis while selecting stocks for their portfolios. Here an analyst examines factors such as the company’s balance sheet, earnings ratios, business environment, to name a few, and based on the findings, decides whether to buy that stock or not.
However, with markets advancing and sophisticated investors entering the fray, newer strategies such as quantitative strategies based on mathematical models are gaining popularity.
Quantitative funds follow a scientific approach to invest in stock markets based on mathematical calculations. The portfolio of a quant fund is based on a computer-generated quantitative analysis employing a mathematical model, with no human intervention.
“There could be models which include stock fundamentals and technicals such as past price movements,” says Radhika Gupta, founder and director of Forefront Capital Management, which offers quant-based portfolio management services, based on Nifty and Nifty Junior indices.
Once the model is tested, there is little scope for human intervention, unless there are exceptional scenarios such as fraud, natural calamity or some such extraordinary event. Quantitative analysis is undertaken using computer-based models, which are designed by the respective manager.
“Sophisticated investors looking for portfolio diversification in terms of strategy should invest in quant funds,” says Vetri Subramaniam, head-equity funds, Religare Mutual Fund. The audience includes those who believe in qualitative aspects of investment process and do not focus solely on returns.
Investment professionals practising this discipline prefer all securities and assets, for which a liquid market is available. Though this has a long-standing history in developed markets, in the Indian context, this is yet to emerge fully owing to many limitations such as shallow markets, lack of modern derivative instruments and regulatory aspects.
However, as institutional participation increases in equity markets in India, this style of investing is likely to gain momentum. In India, one may come across quant investors who focus on select strategies. They include pair trading, directional strategies on benchmark Nifty and a small gamut of stocks with a liquid derivatives market. Strategies such as pair trading are meant for absolute returns seekers, whereas directional strategies may attract seekers.
In other words, the strategies in quantitative landscape cater to a wide range of investors. However, you have to clearly understand your objectives and the best strategies that may help achieve them.
Some mutual funds and few portfolio management providers have made this option available to Indian investors. Sharekhan, for example, offers quant-based investing under a product called Nifty thrifty.
“Based on the model, the fund is either long or short on the Nifty,” says Rohit Srivastava, a portfolio manager at Sharekhan.
However, a point to note that quantitative investments are not absolutely safe. The biggest issue with these products is one need not necessarily understand the reasoning behind stock picking or initiation of a trade. Here, investments done based on fundamental analysis of companies have an edge over those based on quantitative analysis.
Also, quantitative investors typically maintain exposure to derivative products, exposing them to risks associated with leverage.
In such circumstances, risk management techniques become important and emerge as the deciding factor between success and failure. Instances such as failure of Celebrated Hedge Fund Long-Term Capital Management, that used to employ quantitative strategies, clearly underline such issues with this investment style.