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Quant Mutual Fund investigation by SEBI: Is your money safe?

Posted on 24 Jun 2024
Author: Sayan Sircar

Tags: News ; Mutual Funds

10 mins read
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This article discusses the news about the alleged front running inside Quant Mutual Fund which is being investigated by SEBI.

Quant Mutual Fund investigation by SEBI: Is your money safe?

📚 Topics covered:

What is the news on Quant Mutual Fund investigation by SEBI?
What is the impact of front-running on mutual funds?
Is our money safe with any mutual fund?
Will the NAV fall if many investors try to exit?
Can you switch to safer funds from the same AMC?
Are index funds also impacted by front-running?
Will other funds outside Quant AMC get affected by the Quant Mutual Fund investigation by SEBI?
How are Quant mutual funds doing after the start of the Quant Mutual Fund investigation by SEBI?
What should Quant ELSS investors do?
Frequently asked questions on the Quant Mutual Fund investigation by SEBI

What is the news on Quant Mutual Fund investigation by SEBI?

On Sunday 23-Jun-2024 evening, Moneycontrol broke the news of a SEBI investigation at the offices of Quant Mutual Fund on allegations of front-running.

Front-running is when a trader uses inside information about client orders to make trades for personal gain.

Front-running is not new. The Axis Mutual Fund case, which was discovered in May 2022, faced the same type of investigation and led to the barring of the fund manager and other related entities.

What is the impact of front-running on mutual funds?

Due to front-running, the fund manager and others know which stocks the fund is buying (which causes the price to go up) and can buy those same stocks in their personal accounts beforehand. Once the stocks go up due to a large buy order, these personal stocks can be sold at a profit. The reverse happens in the case of selling.

The impact of front-running is that the fund ends up buying the shares at a higher price since others have very recently purchased the same stocks. The same happens during selling since a lower price for the same shares is received.

Front-running and similar allegations break the trust that investors place in their fund managers to manage their money on their behalf.

A live example of front-running, from the Axis 2022 case, is available on page 56 of the PDF order on SEBI’s website: Interim Order-cum-Show Cause Notice in the matter of Front Running of the Trades of Axis Mutual Fund

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Is our money safe with any mutual fund?

In India, mutual funds are set up using a three-step process:

Sponsor: The sponsor starts the mutual fund and gets approval from the Securities and Exchange Board of India (SEBI). They are like the promoters of the company that will manage the fund.
Trust and Trustee: Once SEBI gives the green light, a Public Trust is created under the Indian Trust Act, of 1882. Trustees are appointed to run the trust, protect the interests of the investors, and make sure the fund follows SEBI’s rules.
Asset Management Company (AMC): The sponsor then creates an AMC to manage the fund. The AMC must follow the Companies Act, of 1956. The mutual fund structure works like this: Sponsor > Trust > AMC > Individual Scheme > Investors

Due to the Trust setup, a mutual fund, its employees, and anyone else cannot really run away with the investor’s money. But other risks and issues can come from news like this.

Will the NAV fall if many investors try to exit?

It depends.

The fund will first pay exiting investors from the cash it holds. As per Valueresearchonline, this is the cash position (as a percentage of holdings) for five of the biggest Quant funds (in terms of Assets Managed almost ₹55,000 crores) as per 23 June 2024 data.

Funds	Type	Cash %	AuM (Cr)	1Y Return
Small Cap Fund	Smallcap	2.67	21,243	67.80%
Active Fund	Multicap	1.04	10,204	55.84%
ELSS Tax Saver Fund	ELSS	3.53	9,860	61.54%
Mid Cap Fund	Midcap	0.34	7,953	74.21%
Flexi Cap Fund	Flexicap	3.47	6,272	63.51%

Once the cash becomes low, the fund will have to start selling shares. Now, everyone knows exactly which stocks these funds hold (via monthly disclosures).

The problem will happen with stocks that naturally have lower liquidity like small and mid-cap stocks vs. large-cap stocks.

Liquidity tells you how many shares you can buy/sell without moving the market against you.

For example: if a share trades on an average ₹1 crore value per day, selling ₹50 lakhs of that share will definitely lower the price. The faster you try to sell, the lower the effective selling price since the market now knows what you are doing. This way, maybe the fund will exit some low-liquidity stocks but will get a lot less money for that.

If the fund does not want to sell some of the low-liquidity stocks it holds, it will sell stocks with higher liquidity. For example, even the small-cap fund holds Reliance Industries, a common large-cap stock. Selling mostly liquid large-cap stocks to handle investor sells will change the characteristics of the fund.

The effect on fund returns will need to be seen.

To understand what to do with these funds in your portfolio:

Can you switch to safer funds from the same AMC?

In theory, you can switch from the equity fund of Quant Mutual Fund into a short-term debt fund to protect your capital.

This plan will not work since the switch is a sell from the source equity fund and will happen at end-of-day NAV like any other sell transaction.

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Are index funds also impacted by front-running?

To profit from front-running, you need to know in advance which stocks are being bought or sold. This statement is the definition of Material Non-public Information (MNPI):

Material means that this information is valuable to those who have it
Non-Public means that the general public, i.e., the stock market, does not know this yet

In the case of index funds, buys and sells are triggered by:

the index provider, like NSE / S&P / MSCI, etc., making changes to the stocks in the index every few months. This information is material but public
the changes in the stocks due to daily market movements. This information is neither material nor public

Therefore, index funds may be considered more immune to front-running than active funds. A skilled and determined person can, of course, find some loophole here as well, though.

An overall investment strategy, without too much exposure to any single AMC, is the prudent thing to do in general.

Will other funds outside Quant AMC get affected by the Quant Mutual Fund investigation by SEBI?

Outside of large-cap funds, it is possible that small and mid-cap funds owned by other AMCs might see a contagion effect:

Quant funds see a lot of redemption
Quant fund managers sell small and mid-cap stocks
Those stocks go down in price
Other mutual funds holding large amounts of the same stocks also go down

How are Quant mutual funds doing after the start of the Quant Mutual Fund investigation by SEBI?

We have a detailed article here on this topic: Are Quant funds underpeforming after the SEBI probe start?

What should Quant ELSS investors do?

ELSS funds do not allow you to sell unless 3 years are completed. This rule applies to every investment you have made i.e. both lump sum and SIP.

You need to open your detailed transaction statement for this fund and then find those units purchased more than 3 years ago. Only those units can be sold.

Frequently asked questions on the Quant Mutual Fund investigation by SEBI

What is the issue with Quant Mutual Fund?

SEBI is looking into Quant Mutual Fund for possibly using inside information to make trades and benefit from them.

What is front-running?

Front-running is when a trader uses inside information about client orders to make trades for personal gain.

Why is SEBI investigating?

SEBI started investigating due to suspicious trading activities and has searched Quant Mutual Fund’s offices in Mumbai and Hyderabad.

What did SEBI do during the investigation?

SEBI searched the offices, took digital devices like phones and computers, and questioned employees.

What has Quant Mutual Fund said?

Quant Mutual Fund said they are cooperating with SEBI and assured investors of their commitment to following rules and being transparent.

How big is Quant Mutual Fund in the industry?

Quant Mutual Fund has grown fast, with assets increasing from ₹100 crore in 2019 to over ₹90,000 crore now. It is one of the fastest-growing mutual funds in India having taken over Escorts Mutual Fund in 2018.

How could this affect investors?

Investors might face higher costs and worse trade prices due to artificial price changes from front-running. It could also reduce trust in the financial markets.

Has this happened before?

Yes, there have been other front-running cases in the Indian mutual fund industry where SEBI took action against those involved.

What could happen to Quant Mutual Fund if found guilty?

If found guilty, Quant Mutual Fund could face fines, suspensions, and legal action. This could also lead to withdrawals and affect the value of their funds.

What should investors do?

Investors should stay calm and avoid making quick decisions. It’s wise to wait and see how the situation unfolds, as redemptions might impact fund values.

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