How this mutual fund is beating its peers

An algorithm, instead of the fund manager, decides which stocks are attractive and give returns to beat the market.

Quant funds are the source of much debate in certain markets. Not to mention they are also shrouded in a fair amount of controversy. Back in India, the number of such offerings is few simply because they continue to rank low on the popularity and awareness parameters.

Quant funds are those where the fund manager uses computer-based models to help her/him determine which stock is attractive. There are a few such funds in India but are scant compared to the number of actively managed funds where fund manager's discretion is dominant.

There is one fund though that is making investors sit up and take notice. It has steadily climbed its way to the top of the pecking order in the performance charts. Which is an irony of sorts. Ask financial advisors in India how one should view quant funds and the retort will be that it's safe to position such funds as low risk-moderate return propositions. But here we have one that is beating the other actively managed funds in its category with no star fund manager patting himself on the back.

Edelweiss Diversified Growth Equity Top 100 Fund (EDGE Top 100) debuted a little over four years ago. Going by its name, one can see immediately that it is a large-cap offering, which means it will invest in the largest stocks listed on the stock exchange. What you will get here is a diversified portfolio of at least 50 quality stocks. But do note, the fund won't be a pure large-cap offering at all times.

The investment mandate does give the leeway to dabble in mid-cap stocks. So smaller fare can touch around 20 per cent of the portfolio while the debt / cash allocation can move up to 35 per cent. Though the fund aims to stay invested at all times, there have been instances otherwise. March 2012 is a case in point where the debt/cash allocation touched 18 per cent.

The quant model designed by the asset management company will throw up the selected stocks and their respective weightages, which means, how much should be allocated to each stock. This model works on certain input variables.

The stock selection will be done on various paramaters that are keyed into the system -- growth, valuation, performance (in terms of price) and consistency (in terms of margins).

The weightage to a stock will be based on its volatility, quality and liquidity.

A co-relation matrix is also in place to ensure that not too many highly co-related stocks are dominating the portfolios. The co-relation will be ascertained on various parameters. To cite an example, if the parameter is interest rates, three sectors with a strong co-relation would be banking, auto and real estate.

Finally, a constraint is also in place to ensure that the actual allocations are not completely defiant to the weight in the index.

What this does is eliminate the individual fund manager bias and prevent him from going gaga over "favourite" stocks.

On the flip side, the common argument against quant funds is that one can lose out when the market suddenly changes direction or behaves unpredictably. Point noted.

But when investing in equity, one has to take a longer-term view. And where this fund makes a case is by its consistency of returns.

Its performance in 2010 and 2012 has not strayed too far from the Nifty, its benchmark. And its fall in 2011 was significantly less. But if one looks at its current 1-, 2- and 3-year trailing returns, it does leave its benchmark a good distance behind. When stacked up against its large-cap peers, it boldly and consistently features amongst the top 4 in all three time periods.

There is one point worth mentioning though. Just because the fund uses a quant model to make its picks, don't assume that the portfolio is, by and large, static. It is not an index fund. If we look only at the portfolios from the start of this calendar year, there are some interesting observations in the top 10 stocks. The allocation to each does not stay constant and there is a fair amount of shuffling. Let's look at some examples (this data only refers to the top 10 stocks of the January 2013 to June 2013 portfolios).

ITC made an appearance only from February onwards and its allocation has fluctuated between 4.55 per cent to 6.7 per cent of the portfolio. Though it was not in the top 10 in January, it was the second highest holding in February. Sun Pharma and Yes Bank featured only in April. On the other hand, HDFC Ltd made an appearance every month except April. SBI appeared only in January and April.

So if there are any doubts as to this fund not being an actively managed fund, this should clear the air. This is a diversified equity fund that falls in the large-cap space. It just tends to rely more on its software to design the portfolio. And looking at its track record, it has been doing a fine job.

Fund: Edelweiss Diversified Growth Equity Top 100 (EDGE Top 100) Fund

AMC: Edelweiss Mutual Fund

Fund manager: Paul Parampreet

Benchmark: CNX Nifty

Type of fund: Open ended, diversified equity

Investment options: Growth, Dividend

Label: Brown, indicating high level of risk since it is an equity investment

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