InvestorQ : What is the stock-picking model in mutual funds?
Manish Mehta made post

What is the stock-picking model in mutual funds?

Nitin Shah answered.
3 weeks ago

Typically, quant-based schemes have a data-driven approach to pick stocks. They create a stock-picking model using various parameters. The model then selects stocks that match the parameters. The idea is to free stock-picking from human intervention/bias. The entry and exit times are also decided by the automated program, unlike the actively managed funds.

However, quant funds, unlike index funds, are not entirely free from a fund manager. In these funds, the fund manager usually focuses on the robustness of the model and keeps a check on whether the model is working optimally or needs tweaking. As of now, there are only three quant funds in India- Nippon India, DSP Investment Managers, and Tata Asset Management. Mostly, fund houses have their own proprietary model based on which stocks are selected. These models might include parameters such as P/E, P/BV, earnings, growth, financial ratios (fundamental analysis), the performance of the stock as compared to the industry. Therefore, it involves extensive data crunching. The method eliminates the fund manager’s authority to choose a stock.

The system picks the stock only if it fits the criteria fed into the fund’s model. The style or approach followed in such a method of investing is termed as “factors”. The main objective of the fund is to beat their respective benchmarks by investing in a concentrated portfolio of securities. Nevertheless, the elimination of human bias is not a guarantee that the fund will perform exceedingly well. This is because quant funds are modelled based on past performance, which is not an indicator of future performance. Thus, these kinds of mutual funds do not guarantee returns, just like other sub-categories.