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For those who hold machines over men

In 1936 classic ‘Modern times’, Charlie Chaplin is reduced to a single-action worker who just has to tighten bolts as machines have taken over.

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MUMBAI:  In the 1936 classic ‘Modern times’, Charlie Chaplin is reduced to a single-action worker who just has to tighten an assembly line of bolts as machines have taken over everything else. He is even put on an experimental feeding machine that tries to cut down the time ‘wasted’ in having food.

Seven decades later, Nitish Sikand, the manager of Lotus India’s latest offering is facing a similar predicament. Nitish will be the fund manager, but he won’t take any call on the investment decisions of the fund. Machines would.

Lotus India is venturing into a man-less model of fund management. Its quantitative product, called AGILE Fund (Alpha Generated from Industry Leaders Fund) will take concentrated bets (9% each) on just 11 stocks recommended by a computer generated model.

Popularly known as Quant funds, these funds have been around in developed markets for nearly 30 years and operate on the basis of computer generated mathematical models. The objective of this scheme is to generate capital appreciation by investing in a passive portfolio of stocks selected from the industry leaders on the basis of a mathematical model.

The USP of these quant-based funds is that they take out the human emotion in the process of investing. Another advantage they have, somewhat obviously, is that quantitative models can examine a much larger universe of stocks than human analysts.

However, while seeking to eliminate the human errors by entrusting the investors’ funds to computers, the quantitative model inherently eliminates the benefits of human intelligence like corrective action to sudden risks.

In August, the Forbes magazine reported that Goldman Sachs’ Global Alpha Fund is in trouble and there were rumours it might be wound up. Global Alpha was a mega $9 billion hedge fund, and a quantitative fund at that.

When the market follows the laws of probability and behaves predictably, these funds can give good returns. So had Global Alpha, when it gave 40% returns in 2005. But, when some sudden risk emerges or the market turns volatile, these funds can bleed as the manager has no control over them.

When global markets were rocked by a confluence of circumstances including the unwinding of the carry trade, the credit crunch and a heightened fear of risk, Global Alpha crumbled.

It has given negative returns of 33% so far this year. By end-September, from over $9 billion, its assets had reduced to $6 billion due to redemptions and are headed further down.

Global Alpha was not an isolated case. Back in 1998, Long term Capital Management (LTCM), another quant-based hedge fund, lost over $4.6 billion as its computer models failed to provide for the possibility of the Russian government defaulting on its government bonds.

The fund was successful initially, generating annualised returns of over 40% in its first years. But in 1998, the fund lost $4.6 billion in less than four months because the computer models did not take into account the Russian government defaulting. Such risks get amplified when the quantitative model takes concentrated bets.

The AGILE Fund will  follow a model wherein on the first trading day of every month, 11 stocks are selected. At any given time, the fund will have only 11 stocks in its portfolio and these stocks may or may not be the same as those selected the previous month.

The manager will put 99% of the money in these stocks; the rest would be in debt and money market instruments. Some basic parameters designed for first-level scrutiny of stocks are as follows:

*Market capitalisation of the stocks chosen should not be less than the m-cap of the last stock on the Nifty;
*Floating stock should not be less than the least floating stock of the Nifty;
*Stock should have a price history of one year before the date of investment;
*Industry represented by the stock should figure in the composition of Nifty.
Ajay Bagga, CEO of the fund house declined to reveal further details about the model of the fund saying it was a result of “months of hard work” by his team and other active managers could try to copy the portfolio if he did.

“This fund will redefine the product suite available in the market and will provide investors a model-based alternative to the existing value- and growth-based investing philosophies. Based on the extensive back-testing done, we believe that this offers an attractive additional asset allocation opportunity to equity mutual fund investors,” said Bagga.

However, investors strong enough to keep their nerves through difficult times can subscribe to the fund with a long-term view.
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