DSP Mutual Fund is launching the new fund offer (NFO) of DSP Quant Fund from May 20. The name ‘quant fund’ indicates the use of quantitative factors will decide the course of the investment. The DSP Quant Fund is an open-ended equity scheme that will systematically follow investment rules tested over market cycles with minimum human biases. What will all this result in? The fund-house hopes that it will help deliver superior returns as compared to the underlying benchmark – BSE200 TRI – over the medium to long term. RupeeIQ decodes the fund and helps you take an informed decision,
Quant way to eliminate losers
There are over 5,000 listed companies. So, why do most fund houses invest in 350-odd stocks? The reason is simple. Not all of the 5,000 companies are good enough. Winning more is losing less! To lose less, one must remove the loser stocks. By loser, we do not mean a stock that has lost value. No. A loser stock is a bad stock which is not worth your time or space in your portfolio. There are various rule-based ways in which one can eliminate such stock from a portfolio. The more effective these rules, the lower are the chances of having ‘bad apples’ in your portfolio.
From the universe of BSE 200 TRI index companies, the DSP Quant Fund’s strategy is to eliminate companies displaying any of the below characteristics:
1. Highly leveraged companies – DSP Quant Fund uses Debt to Equity ratio (excluding financials) to check over leverage. In this way, out of the BSE 200 TRI, it eliminated 14 stocks or 4.9% weight in the benchmark.
2. Highly volatile stocks – It uses the ‘beta’ metric to spot highly volatile stocks. In this way, as many as 70 stocks are removed from the benchmark.
3. Misalignment of management incentives – Using ownership criteria, DSP Quant Fund removes 33 stocks or 9.7% weight in the benchmark,
4. Earnings quality & accounting screens – For this, the fund is using forensic accounting screeners, etc. As much as 40 stocks will go out due to this trick.
In this way, DSP Quant Fund eliminated 99 stocks from BSE 200 TRI (Total Return Index). This doesn’t mean the fund will invest in the rest of the stocks. This process, in fact, results in the selection of about 50 companies to whom appropriate weights are allocated quantitatively.
Buying good companies/stocks
Wealth creation is possible when a fund buys good stocks. Here, the use of quantitative parameters is supposed to help.
DSP Quant Fund will choose fundamentally sound stocks, tested for consistency and alpha over long periods, across market cycles and different geographies and have relatively low correlation with each other, maximising diversification benefits for the portfolio.
Quality of a good company can be assessed by using metrics like ROE, and earnings growth consistency.
Growth of a good company can be understood by using estimated earnings growth (consensus numbers).
Valuation of a good company can be understood by using metrics like dividend yield and free cash flow yield.
Constructing the portfolio
The DSP Quant Fund will begin with BSE 200 TRI index stocks but eliminate stocks based on exclusion criteria. It will then assign percentile scores for each of the selected factor. Then, it will sort based on average percentile rank and input to the optimizer. Of course, there are some more rules. For instance, stock level constraints are 10%, or 10X of weight in BSE 200 TRI, whichever is lower (avoid concentration, ensure liquidity/capacity).
Sector level constraints are sector neutral, max sector active weight 10% (diversification, avoids the risk of sector rotation and back-tested for alpha).
Portfolio factor exposure will be based on maximizing portfolio level factor exposure (average percentile rank across all five factors).
Also, there will be rebalancing on a semi-annual basis (to minimise portfolio turnover).
Disadvantages of quant model
A quant model can fail too. A portfolio made from quant factors can underperform. DSP Quant Fund says that under-performance can happen if there is sentiment driven rallies/market euphoria (not backed by fundamentals) such as 2007 commodity super-cycle peak and 2014 change in the government regime.
The model can underperform if there are market reactions based on actual or expected changes in policy/regulation or events, like example PSU bank recap of Oct 2017.
Who should invest in this fund
According to DSP MF, there are four things an investor keeping money in this fund should abide by.
1. Investors who want a well-diversified large cap oriented CORE portfolio can invest in DSP Quant Fund
2. Investors who want an efficient strategy that is designed to beat the benchmark using rational principles combined with scientific risk management can invest in DSP Quant Fund
3. Investors looking at a minimum 7-year investment horizon. This is very interesting. So, if you don’t have 7 years, don’t bother. We are not saying this — the fund house itself says so.
4. Investors, who do not want momentum chasing investment style with high turnover, can invest in this fund.
Anil Ghelani will manage the fund. Ghelani has been working with DSP Group since 2003 and is currently Head of Passive Investments & Products. Previously, he served as the Business Head & Chief Investment Officer at DSP Pension Fund Managers and prior to that leading the Risk and Quantitative Analysis team at DSP Mutual Fund responsible for monitoring of portfolio risk and buy-side credit research on companies across various sectors.
Prior to joining DSP, he has worked at IL&FS Asset Management Company and at S.R. Batliboi a member firm of EY. He is currently serving in volunteer capacity as a Director and Vice Chairman of the CFA Society India.
Exit load – 0%
Asset Allocation – Equity and equity related instruments including derivatives: 95% to 100%; debt and money market instruments: 0% to 5%; Units issued by REITs & InvITs: 0% to 5%
NFO closes – June 03, 2019.
Fund house speak
Kalpen Parekh, President, DSP Investment Managers said, “Investing is a blend of Art which is the judgment and beliefs of fund managers and Science of using these principles more consistently and reducing personal biases. The DSP Quant Fund is a mix of converting good investment principles of having good companies at good prices held for long periods of time into rules and then following these rules consistently without our personal biases. These rules have been tested for their effectiveness in generating better than benchmark returns. We are happy to bring a scientific equity product that respects the good investment principles that have generated durable alpha and designed in a model to minimise biases.”
Aparna Karnik, Senior Vice President &Head – Risk and Quantitative Analysis, DSP Investment Managers said, “DSP Quant Fund is designed to provide investors a well-diversified large-cap oriented core portfolio built around principles of quality, growth, and value. We believe such ‘smart beta’ funds combine the merits of both active and passive investing in a cost-efficient manner and can play a complementary role in an investors’ overall portfolio”
RupeeIQ take – Many years ago, Reliance Quant Fund was launched. It invests in an active portfolio of stocks selected on the basis of a Quant model. Over the 1, 3, 5 and 10-year time periods, the fund has underperformed the BSE 200 TRI index. There may be various reasons why the Reliance Quant scheme has flopped. Not all quant investing is high frequency/algorithmic trading. The DSP Quant Fund does not follow this style. We like the fact that its portfolio will be rebalanced only on a semi-annual basis to avoid excessive transaction cost and turnover. On its part, DSP Quant Fund aims to be a large-cap oriented portfolio of stocks. It is clear that the DSP Quant Fund follows a three-step process of elimination, selection and assigning stock weights to make the portfolio. This fund can be added to your portfolio if you have already constructed one. Do not immediately make this fund the core of your investment portfolio. Conservative investors, who draw comfort from a track record, may also choose to wait for some time before investing in the fund.