3 ways in which front-running can impact Quant Mutual Fund investors

The illegal practice of front-running, which is being suspected by Sebi at the Rs 93,000-crore Quant Mutual Fund, can impact not just lakhs of investors in the asset management firm but also shareholders of small and midcap stocks. While the allegations, even if found to be true, pose no systemic risk, there might be an impact in the near term.

Let's understand how front-running can potentially hit investors:

1) Impact cost

Front-running is an illegal and unethical practice of someone trading in shares on the basis of advance information given by a broker, dealer, analyst or other executive at a market intermediary in their personal account before the trades are conducted by that entity.

Such transactions, carried out before large trades are made by a big client like a mutual fund house, increases the cost of acquisition of shares for the concerned fund house, thus adversely affecting the interest of common investors. This happens because buying in large quantities by those involved in front-running trade can drive share prices higher. So when the fund house starts buying, it ends up paying a higher price. Front-running can, therefore, impact returns for mutual fund investors.

Also read | Quant Mutual Fund front-running case: What is it and should investors be worried?

2) Redemptions leading to fall in NAV

The most direct impact of such allegations is redemption which in turn affects the Net Asset Value (NAV) of the schemes.

"Front-running erodes investor trust in the fund house. The investigation itself can create uncertainty, causing investors to hold off on further investments or even redeem existing ones until the situation is resolved," said Amit Goel of Pace 360.

The near term performance of various schemes run by Quant can, therefore, be hit.

Prime Investor, which advises investors on mutual funds and other products, has issued an exit call on all equity and hybrid funds of the AMC saying the news can cause enough damage to sentiment and impact redemptions.

"An exit is further necessary in Quant funds given that many of their stocks are momentum plays, and sudden redemptions and disruptions in inflows can have a greater impact on such strategies," the research firm told clients while taking a conservative view.

3) Selling in stocks in which front-running is suspected

The fall in NAVs may not just be due to redemption pressure which may have forced fund managers to hit the sell button. The drop in NAVs can also be due to selling pressure in stocks owned by the mutual fund house. This impacts not only investors in Quant MF but also shareholders of the stocks in which front-running is suspected.

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