Quant’s Front Running Allegations: What Should You Do?

Yesterday (on 23rd June 2024), a business news platform Moneycontrol reported that SEBI had conducted search and seizure operations in Quant AMC offices (link). The operation was supposedly conducted on suspicion of front-running operations. On its part, the AMC has acknowledged via email to its existing unitholders, that it has received inquiries from SEBI.

First things first – from what we know from public information, this is a search operation by the regulator on suspicion of front-running. It is not a final verdict as of now.

But of course, in such things, there is never a smoke without a fire too. As a result, investors are likely to get worried about this event and whether their money is safe or not.

More so because Quant is an aggressive AMC that has been in the news in recent years given its table-topping performances across categories. The table below shows Quant’s non-sectoral pure equity funds with at least a 3-year vintage:

It is also the fastest-growing AMC in the country with assets under management growing from just a few hundred crores in 2019 to Rs 90,000+ crore in 2024 now.

The AMC has sent out an email to its existing investors (image below) to address this issue, but it doesn’t say much.

If you don’t know what is front-running, then here is a short primer (via an article in Mint – link):

Front-running, also known as tailgating, is a form of market manipulation. It is trading in a stock or a financial instrument by a broker who has inside information about a future transaction that would affect its price. The broker works on the basis of information that is not out in public, on whether a firm is about to buy or sell, or issue recommendations, that would affect the price of securities in the market. SEBI defines front-running as an unethical practice where brokers trade an equity based on information from the analysis department before their clients have been provided the information.

So when a fund manager or other beneficiaries buy shares in their personal accounts before the fund/scheme purchases the shares (generally in large quantities), the prices generally move up. And lower the marketcap of the stock being targeted, the higher would be the impact on its price when the fund starts buying shares in large quantities. As a result, the early buyers (who front ran) make profits.

This is obviously unfair. And in the eyes of the market regulator SEBI, it is not just illegal but is strictly banned as well!

This is not the first time this has happened, just a couple of years back, the Axis Mutual Fund went through a front-running scandal.

Before 2021, Axis equity schemes were chart-toppers. But post the front-running scandal, the fund house is still struggling to regain its footing.

The data (as per a CNBCTV18 article – link) clearly shows consistent underperformance, with many schemes trailing behind their benchmarks and they have mostly struggled to maintain their pre-scandal performance levels. Here’s a look at the yearly returns of some of the popular Axis Mutual Fund schemes:

And it is not just the performance that has taken a hit. The fund house has also experienced a decline in money inflows, reflecting a loss of investor trust in the aftermath of the scandal.

Please note that this is different to what happened in Franklin Templeton Debt MF Crisis.

So coming back to the Quant AMC news again.

Existing Quant MF Investors are likely to get worried about this event, more so those who have recently started investing in their schemes (given a huge increase in AUM in recent times).

So all said and done, how should you think about this event?

• If too many investors get jittery and decide to start exiting simultaneously, this will lead to redemption pressures and negatively impact the fund NAV.
• More so if the selling pressure increases due to mass redemption in the low-float stocks and/or in the funds that hold large quantities of midcap and smallcap stocks. The table below shows which of their main equity schemes have how much exposure to Large/Mid/Smallcap stocks:

• But to be fair, it is still too early to understand the impact of this event on the redemption pressure as at the time of writing, very little information is available in the public domain. This is a developing story so it needs to be addressed accordingly.
• My guess (I repeat), my guess is that some investors will definitely decide to exit and hence some redemptions will happen. But will it be too large to impact NAVs too much? The probability of that happening seems comparatively less. Remember the funds also have cash/equivalents and more liquid largecap stocks in the portfolio that can be used to handle temporary liquidity concerns rising due to redemption pressures.
• Also understand that in SEBI, we have one of the world’s best and most investor-friendly regulators. So money invested in stocks via AMCs is safe. Though we will get to know about the outcome of all of this in the coming days/weeks, I am sure SEBI is doing everything to address the investor’s concerns on this issue.
• Also remember, that SEBI in recent times, has already been pushing AMCs to conduct regular Stress Test & Liquidity Analysis in respect of Mid Cap & Small Cap Funds. This I guess was to gauge how redemptions/liquidity will be managed in case mass selling happens due to market dynamics or events like the one we are discussing.
• That said, there is no need to panic first of all. And don’t overreact. In fact, sufficient information isn’t available right now to take a drastic call.
• Waiting and watching for now may not be a bad thing to do. In any case, how the AMC ran its schemes was highly aggressive and not suited for most investors. In case, investors had some exposure, I guess they would have been wise enough to limit it to a small portion of the overall portfolio. If not, then this is a risk they willingly took by going after returns without looking at what brought those returns. Isn’t it?
• But if you are too worried and want to take a conservative (but hurried view), more so if you have a high allocation to the fund house and its schemes, then you would anyways be looking at reducing the exposure.
• This reminds me to remind you that these are the events which highlight why Fund House (AMC) diversification is necessary. Never invest in the scheme(s) of just one fund house.
• The best thing to do if you are confused? Please reach out to your SEBI Registered investment advisor or the person through whom you invest in mutual funds. Given your unique portfolio and allocations, they would be in the best position to help you make sense of this all.

Important Note – This is a developing story. So we need to keep track and act accordingly based on new inputs as and when they arrive.

Disclaimer – The views expressed above should not be considered professional investment advice or advertisement or otherwise. No specific product/service recommendations have been made and the article itself, is for general educational purposes only. The readers are requested to take into consideration all the risk factors including their financial condition, suitability to risk-return profile and the like and take professional investment advice before investing.

My views on this topic were also quoted in a few media outlets after I published this article

• Link to views in Mint (June 2024)
• Link to views in Outlook Money (June 2024)
• Link to views in Business Standard (June 2024)