What Are Quant Funds?

The fund team designs a model, a set of rules that scores companies on chosen measures. For example, a model might favour companies with strong and stable profits, reasonable valuations and rising share prices. Each month or quarter, the model ranks stocks and the fund rebalances to hold the top-ranked ones.

Humans still build, test and oversee the model, but day-to-day stock choices follow the rules.

Momentum: stocks that have been rising tend to keep rising for a while.

Quality: companies with strong balance sheets and steady profits.

Value: companies that look cheap compared with their earnings or assets.

Low volatility: stocks whose prices move less than average.

Our page on factor and smart beta funds explains these factors in more detail.

Factor index funds follow a published index built on one or more factors, such as a momentum or quality index. A rule-based active fund is usually managed differently, with the fund house own model that it can adjust over time.

Factor index funds are more transparent and often cheaper. Model-driven active funds have more flexibility but less visibility into the exact rules.

• Discipline: rules are followed even when markets are emotional.
• Consistency: the same process is applied every time.
• Breadth: models can scan hundreds of companies quickly.
• Less key-person risk: results depend less on one manager.

Back-testing bias: a model can be tuned to look great on past data and then disappoint in real markets.

Regime change: a factor like momentum can work well for years and then suffer sharp reversals when markets turn.

High turnover: frequent rebalancing can raise costs. Our page on portfolio turnover ratio explains why that matters.

Crowding: when many funds chase the same signals, the edge can fade.

Some model-driven funds showed very strong returns in certain periods, which drew a lot of new money. But strong recent returns often reflect one factor doing well in one market phase. They may not repeat.

Look at how the fund behaved in falling markets as well as rising ones. Our page on rolling returns explains how to judge consistency.

It depends on the model. Momentum-heavy models can be quite volatile, because they hold whatever is rising, including mid and small caps. Low-volatility models are designed to be steadier.

Check the fund riskometer, its holdings by market size, and its standard deviation. Our pages on the riskometer and Sharpe ratio and standard deviation explain these.

The scheme information document and the fund house presentations usually explain the model factors in broad terms. If the description is vague, or you cannot understand what the fund is trying to do, be cautious.

Our page on the scheme information document explains where to look.

Actively managed rule-based funds usually have higher expense ratios than index funds. Add the hidden cost of trading from high turnover, and the total cost can matter.

Compare costs between similar funds. Our page on expense ratio explains how costs work.

An investor who already has a solid core of diversified funds, understands that results can differ a lot from the market for long stretches, and wants a different style as a small part of the portfolio.

Our page on diversification explains how to add such a fund without overdoing it.

Beginners, people who would be upset by long periods of lagging the market, and anyone choosing a quant fund only because of last year return. For a first fund, a simple diversified fund is usually a better start.

• Which factors does the model use?
• How often does it rebalance?
• How did it do in the last market fall?
• How much overlap does it have with my existing funds?
• Is the cost reasonable?

The word "quant" also appears in some fund house names. A fund house name does not tell you whether a particular fund uses a quantitative model. Always read the scheme category and approach.

Fund houses sometimes adjust their models when they find a factor is no longer working, or when market conditions change. That flexibility can help, but it also means the strategy you bought into may not be exactly the strategy you hold a few years later.

Read fund house updates and fact sheets once in a while to see whether the approach has shifted. If the style has changed in a way you are not comfortable with, it is fair to review your holding.

Index funds are the simplest rule-based investment: they hold the companies in an index in set proportions, with no judgement at all. Factor and quant approaches build on that idea with more complex rules.

So the real question is not whether rules are better than people, but whether a particular set of rules, at a particular cost, adds value over a plain index fund. Our page on index funds explains the simplest option.

• These funds follow rules and models to pick stocks.
• Strengths: discipline and consistency.
• Weaknesses: model risk, turnover and regime changes.
• Use them small, alongside a diversified core.

We are distributors rather than investment advisers and we recommend no schemes. If you want help understanding a quant fund you are considering, get in touch.