Kotak Quant Fund: Maximizing Returns, Minimizing Volatility

In a significant leap towards innovation and investment strategies, Kotak Mahindra Mutual Fund is set to launch its groundbreaking product, the Kotak Quant Fund (KQF), on July 12. The fund’s unique approach lies in leveraging the prowess of computerized algorithms combined with human expertise to handpick potential stocks.

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This new venture marks an exciting foray into uncharted territory for a fund house that has already established a commendable track record in the field of equity investments.

The process behind KQF revolves around extensive screening and filtering of stocks. Beginning with a wide pool of 800-1,000 stocks, the fund managers intervene to narrow down the selection to a carefully curated basket of approximately 150-200 stocks. Through this meticulous weeding-out process, stocks with low liquidity, weak financials, and questionable governance are systematically eliminated, leaving behind a promising universe of investment options.

So, how does KQF ensure an optimal balance between maximizing returns and minimizing volatility? By employing a combination of human expertise and advanced algorithms, the fund aims to identify stocks that exhibit resilience during market volatility while showcasing potential for growth in favorable market conditions. Ultimately, KQF strives to protect investors from sudden market downturns while capitalizing on upward market trends.

KQF’s methodology involves a two-step approach. Initially, the fund managers meticulously shortlist a set of 35-50 stocks based on momentum and volatility factors from the pre-selected universe. These chosen stocks exhibit a unique combination of high growth potential and low volatility, making them attractive investment opportunities. The subsequent step involves the algorithm’s active role in managing the portfolio, ensuring swift adjustments to market dynamics and filtering out illiquid stocks that could impact tracking errors.

Harsha Upadhyaya, Chief Investment – Equity and Debt at Kotak Mahindra AMC, emphasizes that KQF’s active management effectively eliminates concerns related to replicating the portfolio. Unlike traditional smart-beta passive funds that often encounter challenges with mid-cap and small-cap stocks during circuit filters, KQF’s active approach enables the fund to mitigate such liquidity issues at an early stage. Furthermore, KQF can actively respond to factors like high impact cost, inflows or outflows, and corporate actions, ensuring timely adjustments to emaintain a robust portfolio.

While KQF represents Kotak Mahindra Mutual Fund’s first foray into the realm of quant funds, the fund house’s proven track record in equity funds instills confidence in its ability to navigate this new terrain successfully. Recognizing the significance of expertise in this domain, Kotak AMC has bolstered its quant team by recruiting two skilled data scientists. These experts work in tandem with the fund management teams, building robust models that aid in the stock selection process. The backtesting of KQF’s model since 2005 showcases its outperformance against the Nifty 200 TRI (Total Returns Index) benchmark in 14 out of those years, often achieving a significant margin of 6-25 percentage points.

However, it is important to acknowledge the limitations of quant funds. Ravi Kumar T V, Director of Gaining Ground Investment Services, highlights that these funds tend to rely more on historical data rather than future projections. The selection bias based on a limited set of rules might not fully capture ongoing market realities and shifts in investor sentiment. While KQF has backtested for the past 18 years, Ravi Kumar suggests that an extended testing period spanning 3-4 decades is essential to encompass market cycles, macro volatility, and evolving trends.

It is worth noting that quant funds in India have a relatively short track record, making it challenging to assess their performance across various market cycles. Among the handful of quant funds available, only a select few have a track record exceeding three years. On the other hand, the popularity of single-factor funds, also known as smart-beta funds, has grown considerably in recent years.

Although there is no official industry differentiation between smart-beta funds and quant funds, the distinguishing factor often lies in the level of active management involved. Quant funds exhibit a more significant fund manager intervention, as exemplified by KQF, where initial filtering based on quality and governance is conducted by the fund managers themselves. Subsequently, different methodologies are employed as the algorithm takes charge. This level of active management sets quant funds apart from passively-managed smart-beta funds.

In terms of performance, quant funds have shown mixed results compared to large-cap, large-and-mid-cap, and flexi-cap funds over the past three years. However, many quant funds have outperformed the category averages of more diversified equity funds in the last year. Srikanth Bhagavat, Managing Director of Hexagon Capital Advisors, advises selective exploration of quant and smart-beta funds, particularly for high-net-worth individuals with a well-diversified portfolio and a solid understanding of factor investing.

While some financial experts remain cautious due to the limited historical data associated with quant funds, others recognize the potential they hold. Vinod Jain, Principal Advisor at Jain Investments Planner Pvt Ltd, remains watchful for now but acknowledges the importance of staying informed about this evolving investment landscape.

In conclusion, KQF presents an ambitious venture by a fund house renowned for its skilled equity fund management team and impressive track record. The combined expertise of fund managers and advanced algorithms instills confidence in the scheme’s structure and methodology. Nevertheless, given the unique nature of factor investing and the absence of an established track record, KQF is more suited for investors with a substantial portfolio who can comprehend the associated risks. As KQF sets forth on its investment journey, only time will reveal the true potential of its algorithm in selecting winning stocks and delivering favorable returns.

Summery 

1. Innovative Investment Approach:

   • KQF leverages computerized algorithms and human expertise to handpick potential stocks.
   • Kotak Mahindra Mutual Fund introduces KQF as a groundbreaking product.
   • The fund aims to achieve an optimal balance between maximizing returns and minimizing volatility.

2. Extensive Screening and Filtering:

   • The fund managers meticulously narrow down the selection from a wide pool of stocks to a curated basket.
   • Stocks with low liquidity, weak financials, and questionable governance are systematically eliminated.
   • The process ensures a promising universe of investment options.

3. Combining Human Expertise and Advanced Algorithms:

   • KQF employs a two-step approach: human expertise and algorithm-driven management.
   • Initial shortlisting by fund managers based on momentum and volatility factors.
   • The algorithm takes an active role in managing the portfolio, making swift adjustments to market dynamics.

4. Active Management Benefits:

   • KQF’s active approach mitigates liquidity issues during circuit filters.
   • The fund actively responds to factors like high impact cost, inflows or outflows, and corporate actions.
   • This ensures a robust portfolio and minimizes tracking errors.

5. Proven Track Record and Expertise:

   • Kotak Mahindra Mutual Fund has a commendable track record in equity funds.
   • The fund house has recruited skilled data scientists to enhance the quant team.
   • KQF’s model has shown outperformance against the Nifty 200 TRI benchmark in multiple years.

6. Limitations of Quant Funds:

   • Quant funds rely more on historical data, which may not fully capture ongoing market realities.
   • Longer testing periods spanning several decades are recommended for accurate market cycle analysis.
   • Quant funds in India have a relatively short track record compared to other fund categories.

7. Distinction from Smart-Beta Funds:

   • Quant funds involve a higher level of active management compared to passively-managed smart-beta funds.
   • Initial stock filtering is conducted by fund managers, followed by algorithm-driven methodologies.
   • Quant funds offer unique investment opportunities beyond traditional smart-beta funds.

8. Performance Insights:

   • Quant funds have shown mixed results compared to other fund categories over the past three years.
   • In the last year, many quant funds have outperformed the category averages of diversified equity funds.
   • Selective exploration of quant and smart-beta funds is advised for well-diversified portfolios and knowledgeable investors.

9. Ambitious Venture with Potential:

   • KQF represents an ambitious venture by a reputable fund house with a skilled equity fund management team.
   • The combined expertise of fund managers and advanced algorithms instills confidence in the scheme’s structure and methodology.
   • KQF is best suited for investors with a substantial portfolio who can understand the associated risks.

As KQF embarks on its investment journey, it holds the promise of delivering favorable returns through its unique investment approach.