Quant Mutual Fund: Should investors redeem or stay amid front-running allegations?

On June 23, 2024, news websites screamed how as part of an investigation into possible front-running, Sandeep Tandon’s Quant Mutual Fund is the subject of search and seizure operations by SEBI. If you’re unfamiliar, front running is a deceptive practice in finance where individuals exploit any advanced knowledge of market movements for personal profit. Here’s an explanation of what it entails:

• When a broker or someone with access to private information trades security (like stocks or options) before their clientele or the public at large learns of a significant transaction that could impact the price, this is known as unethical trading.
• Abuse of insider information involves exploiting confidential details, such as knowledge of a substantial client order or an impending firm recommendation expected to influence market prices, to gain unfair profits through pre-emptive trading.

Now, let’s illustrate this with an example. Imagine a scenario where a stockbroker is aware that a major investor is preparing to purchase a substantial amount of a specific stock, which is likely to drive its price upwards. Utilizing this information, the broker promptly purchases shares at a lower price and subsequently sells them after the price surges due to the significant purchase.

What’s wrong with front-running practices?

Front running unfairly advantages individuals with inside information and erodes market trust, essentially appropriating potential profits from others. Most importantly, it is deemed unethical for a couple of key reasons:

• Violation of trust and fiduciary responsibility: In the financial sector, brokers and advisors are entrusted with a fiduciary responsibility to prioritize their clients’ best interests. Front running directly undermines this obligation by prioritizing the broker’s personal gain over the financial well-being of the client. Investors rely on their brokers to act in their best interest, and front-running undermines this trust.
• Dilutes market integrity: Open communication is necessary for a fair and efficient market. By using confidential information to gain an unfair advantage, front running erodes this. This could cause unanticipated price volatility and discourage real investors from participating, which would be detrimental to the market as a whole.
• Unequal opportunity: The fundamental role of a financial market is price discovery, where a security’s value is determined by supply and demand. Front running disrupts this process by manipulating prices with privileged information rather than genuine market dynamics. This results in an uneven playing field where some benefit unfairly.

Front running, to put it simply, is the practice of cutting ahead of the line and pushing people aside to benefit oneself. It’s a dishonest strategy that erodes confidence and creates an unfair marketplace. In most cases, it is illegal, particularly when it pertains to information about a specific client. However, there can be ambiguous situations, underscoring the importance of transparency and ethical behavior.

Should you run away or stay invested?

Quant investors are currently facing uncertainty regarding whether to withdraw their investments from the fund or maintain their regular systematic investment plans (SIPs). Clarifying upfront, based on publicly available information, this is a regulatory investigation prompted by suspicions of front-running. It is not a definitive judgment at this point.

Despite efforts to encourage investors to remain optimistic and rational, many are understandably concerned about this event and the safety of their investments. This is exacerbated by Quant’s reputation as an assertive asset management company that has consistently delivered top performances across various categories in recent years.

Dev Ashish, Founder, Stable Investor explains, “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. 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.”

Elucidating on what investors must do, Ashish added, “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 means that Investors with long-time horizons, especially those with ongoing SIPs or STPs, may opt to hold onto their current assets as they can weather short-term market fluctuations and potentially profit from a rebound. Investors who are thinking about short-term liquidation should, however, steer clear of the fund company's pure equity investment funds to lower risk. This tactic can help lessen susceptibility to changes in the market and ambiguous regulations.