Capital Alliance breaks new ground in capital market with first ‘Quant’ fund

Using mathematical algorithms unique model assures maximisation of returns with minimum risk for medium to long-term investors

The standard adage is high risk-high returns but existing and prospective investors in the Colombo stock market now have an option to benefit from a new fund whose managers assure maximisation of returns with minimum risk over medium to long-term.

Capital Alliance Investments, part of Capital Alliance Partners (CAL), has launched the country’s first-ever ‘Quant’ Fund which uses mathematical algorithms to have an ideal portfolio of stocks and fund allocation to offer better or higher return with the safeguard of lower risk.

Quant funds are popular and have been successful in developed, emerging and frontier markets. The launch of CAL Quantitative Equity Fund in Sri Lanka as a unit trust is following the approval of the Securities and Exchange Commission. Price of a unit of CAL Quant Fund is Rs. 10 each and it is open-ended whilst Unit’s selling and buying prices will be published regularly.

In general Quant Funds build on fundamental stock picking techniques and uses mathematical and statistical tools to aid the selection of securities the fund invests in. It uses risk management as an integral part of the portfolio selection and management process or as CAL explains, it is in-built. Additionally the Fund targets above average returns on a risk adjusted basis with better downside protection than that obtained by traditional funds.

Capital Alliance Investments Head of Investment Management Ashveeni Shanthikumar told the Daily FT that CAL uses a “best of breed” hybrid model (CAL QE) that combines Quant Fund management with traditional fundamental investment techniques.

“Quant funds take the human emotion out of the investment process and have the ability to react and process new information much faster than traditional funds,” she added.

CAL QE Fund uses a multi-factor (around 25) model that screens and ranks over 90 CSE listed companies based on their profitability, operating efficiency and balance sheet strength, financial health, valuations and investment attractiveness. The model then identifies the 12-15 companies to invest in. An optimiser is then run by CAL to allocate funds across the selected stocks.

 “We used data going back six years and the model has proved empirically that the strategy out-performs the market (see graphics) by systematically applying a pre-programmed formula that seeks out low volatility above average companies at below average prices,” said Ashveeni.

In fact Dr. Jagath Wijerathna, Head of the Department of Mathematics, University of Colombo has independently verified the back test results as well.

CAL has a team with a broad experience covering Quantitative and Fundamental investment techniques that is unparalleled in the local industry with prior experience in developing quantitative strategies, fundamental equity research and risk management for Global Investment Banks, Asset Managers and Hedge Funds. For example Ashveeni has over eight years experience in international capital markets and was formerly a senior risk manager at De Putron Fund Management, a London-based hedge fund specialising in Quantitative Equity Funds. Prior to which she worked at JP Morgan London as a senior market risk manager for the equity structured products group. She was also an Associate Vice President at the Quantitative Services Unit of Amba Research in Sri Lanka. Ashveeni also holds a BSc in Mathematics from Imperial College London.

Unlike traditional fund management processes, risk management is directly built-into the CALF QE model. This makes risk management an integral part of the investment process. The CAL QE model also has an inherent advantage over fundamental analysis due to its ability to process and analyse an immense amount of raw data within a short span of time. According to Ashveeni, the algorithm reacts very fast to market movements, and identifies deep value companies, some with little or no fundamental broker research coverage. This gives the CAL QE fund a unique advantage over traditional investment funds, she added.

Explaining the selection process of stocks, Ashveeni said the 25-35 factors applied by CAL help the model identify companies that have predictable cash flows stable earnings high dividend yields and are trading at a discount. “The model builds in an element of risk management by selecting stocks with low volatility and relatively high liquidity,” she said.

When questioned whether Sri Lanka’s capital market is ready for a Quant Fund or whether there is a need among investors, Ashveeni said yes. “Previously though there was a need among investors there was no solution. CAL has the expertise and the experience. Be it in times of volatility, speculative bubbles or bearish stages, the more disciplined medium to long term investors prefer to enjoy a decent return. The model we use at CAL allows investors to achieve higher returns than the market indices without assuming substantially higher risk,” Ashveeni added.

She also opined that CAL also ensures there is a science behind itsfund allocation, a more structured approach and consistency than otherwise. “The investment or fund allocation strategy is backed by algorithms. We ensure we have a risk efficient portfolio, pick attractive companies at below average prices, minimise any volatility of the portfolio and overall achieve the highest risk adjusted return. The process which looks at a much larger base of stocks is entirely automated,” she added. However, CAL will be using inputs from the fundamental research team as part of validation process when required.

CAL QE Fund will go through a rebalancing annually whilst unit holders/investors will get a single-page update of the Fund monthly. Trustee and Custodian of the Fund Deutsche Bank will also provide additional information on request. Whilst there is no front-end cost, other fees involved for a unit holder includes Management Fee – Annual fee of 1.5% per annum of the NAV + 10% of any excess % in ‘net return’ over the growth of the ASPI over the same period. Exit fee – 2% if the units are sold within one year of purchase and Trustee fee – 0.25%.

Capital Alliance Investments (CAI) in a short span of few months of operations has nearly Rs. 1 billion funds under management. It believes that the equity-centric QE Fund is the first of many investment options the company plans to roll out in the future. It already has a Gilt Fund, and a high yield fund CAI’s parent Capital Alliance Partners is a full-service investment bank specialising in the origination, trading and investment in debt, and equity securities.

Apart from Ashveeni, senior management of CAL Investments include Dr. Naveen Gunawardane, Head of Investment Banking at CAL Partners, Ajith Fernando, Group CEO and Brad West, Chief Operating Officer at CAL Partners.