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"Is Your Investment Safe? The Front-Running Probe Explained"

Quant Mutual Fund front-running case

The Stock Markets have got a jolt when the Quant Mutual Fund front-running case came into spotlight. According to sources and the SEBI order copy, In fact, regulator Sebi recently carried out a search-and-seizure exercise at offices of Sandeep Tandon’s Quant Mutual Fund over suspicion that it was being used for front-running activities. At a time when SEBI is expanding its investigation in mutual fund practices, here's another example of mistaken identity that has erroneously branded yet another fund house as 'suspect'.

Investors of Quant Mutual Fund are worried about their investment after SEBI started a probe over suspected front-running activities to the extent of Rs 93,000 crore. The SEBI had reportedly conducted the raids at Quant's Mumbai headquarters and in Hyderabad, where many of its suspected beneficiaries were located as phones, computers and other digital devices recovered from there would reveal who was leaking confidential information out of this asset management company for ill-gotten gains. An ET report explains that the suspicion is two-fold: a dealer from an entity of Quant or a broking firm through which orders are placed by the AMC.

Quantitative funds are gaining traction in India, exemplified by the emergence of AMCs like ABSL Quant Fund and the upcoming SBI Quant Fund, alongside established players such as Motilal Oswal Quant Fund. These funds employ rule-based, data-driven strategies to construct portfolios, offering a departure from human-driven approaches prone to biases. By relying on defined rules and statistical analysis, quant funds aim to minimize decision-making noise and enhance portfolio efficiency. However, their intricate, model-dependent operations and frequent trading based on diverse market signals distinguish them from traditional index and factor-based funds.

The operational intricacies of quant funds, such as the Quant Quantamental Fund, blend fundamental, quantitative, predictive, and cognitive insights to optimize portfolio construction. Yet, these models are often shrouded in secrecy, with AMCs guarding proprietary frameworks. This lack of transparency has led to quant strategies being labeled as 'black box', leaving investors with limited understanding of their inner workings. Critics like Roopali Prabhu of Sanctum Wealth remain cautious due to these uncertainties, highlighting challenges in assessing the factors driving portfolio performance over time.

The primary measure of quant funds' success remains their performance, yet assessing this can be challenging given their relatively short track records in India, typically spanning 3-4 years. Despite notable fluctuations, many quant funds have struggled to consistently outperform the market, though Quant AMC stands out with strong results driven by robust data analytics. Despite the risks associated with their high complexity and limited performance history, experts like Santosh Joseph advocate for recognizing quant funds' potential in leveraging data for substantial gains. Vidya Bala emphasizes their appeal due to consistent performance, suggesting they warrant consideration within diversified investment strategies.

What is front-running?

Front-running occurs when an individual, usually an insider or broker, trades in advance using privileged information. This illegal practice involves a broker or other entity executing orders on a security for their own account, taking advantage of advance knowledge of pending customer orders. By doing so, they can benefit from the price movements that are likely to occur once the larger orders are executed, often at the expense of the clients. For example, if a broker learns that a significant client is about to purchase a large number of shares in a company and then buys shares for themselves beforehand, this constitutes front-running. Such exploitation of confidential information for personal gain compromises market integrity and can negatively impact investors. The practice is both unethical and illegal, and it is prohibited under SEBI regulations.


What occurred at Quant Mutual Fund?

Recently, Sebi's surveillance system flagged potential front-running activities involving entities suspected of having prior knowledge of Quant Mutual Fund's trade orders. There are allegations that executives at Quant may have shared confidential details about trade sizes and timings with certain beneficiaries, prompting an investigation by Sebi. In response, Quant Mutual Fund has pledged full cooperation with Sebi, committing to provide necessary data regularly. They also clarified that they are distinct from another entity named Quant Mutual Fund, which is embroiled in the investigation and faces legal action over name confusion.

Quantum Mutual Fund, not involved in the investigation, emphasized their separate identity through social media and legal channels. They have filed a suit in the Mumbai High Court to restrict the other entity from using a confusingly similar trade name. Despite the legal dispute, Quantum assured investors, distributors, and brokers about the distinction between the two funds, stressing that the confusion arose due to the later establishment of the similarly named entity, Quant Mutual Fund.

Meanwhile, Sebi has been questioning individuals associated with Quant Mutual Fund regarding the alleged front-running, estimated to have yielded profits of approximately ?20 crore. Sandeep Tandon, CEO of Quant Mutual Fund, sought to calm investor concerns, describing the allegations as exaggerated and advising against hasty redemption of investments. In a public statement, Quant Mutual Fund reaffirmed its regulatory compliance and readiness to assist Sebi throughout its review process, aiming to address any uncertainties among investors and stakeholders.

What implications does this have for investors in Quant Mutual Fund?

The fund house faces potential redemption pressures amid negative news flow, likely leading to NAV declines. Smallcap stocks, where Quant MF holds significant positions, may experience selling pressure. Kirtan Shah from Credence Family Office predicts possible underperformance in mid and smallcap stocks due to these factors, particularly if Sebi confirms front-running allegations, triggering further redemptions. Despite near-term challenges, Shah notes the fund's robust stock selection process, highlighting substantial holdings in RIL for liquidity support. Prime Investor advises caution, recommending exits from all equity and hybrid funds of the AMC, citing potential sentiment damage and redemption impacts. They specifically caution against Quant funds, noting their reliance on momentum stocks, which could amplify the effects of sudden redemptions and inflow disruptions.


Could your investment be at risk?

Analysts warn that front-running allegations can damage investor trust in the fund house, potentially triggering redemptions that affect the fund's NAV. The uncertainty from ongoing investigations may also deter new investments and prompt existing investors to redeem until clarity is achieved. However, experts like Amit Goel from Pace 360 reassure that investor money in mutual funds is generally held securely, even in the event of regulatory actions against the fund house, as SEBI prioritizes safeguarding investor interests.


In conclusion, the recent front-running allegations against Quant Mutual Fund have underscored the risks associated with 'black box' quant funds, where complex trading strategies and potential lack of transparency can raise concerns about market integrity. While Quant Mutual Fund has pledged cooperation with SEBI and denied involvement in illegal activities, the episode highlights the importance of investor vigilance and due diligence in navigating such investments. The outcome of SEBI's investigation will be crucial in determining the impact on investor confidence and the future viability of quant funds in India's financial landscape. Investors are advised to stay informed and consider the implications of ongoing regulatory scrutiny on their investment decisions.

- Team IFA