(Bloomberg) - The era of breakneck growth for China’s quantitative hedge funds may be ending as regulatory scrutiny intensifies and some of the $219 billion industry’s most popular trades become increasingly crowded.
After a boom that saw assets under management at algorithm-driven funds in the country jump by fivefold over the past two years, a growing number of firms are now restricting inflows or dialing back expansion plans.
The number of products launched by top Chinese private funds -- the local equivalent of hedge funds -- plunged by more than half in October from a month earlier to 246 and was poised to fall even further in November, according to preliminary data compiled by Shenzhen PaiPaiWang Investment & Management Co., a local research provider. Zhejiang High-Flyer Asset Management, China’s biggest quant firm, is among those suspending inflows to at least some products.
The pullback has been fueled in part by Beijing’s attempts to prevent a rapid influx of money into quant trading strategies that regulators don’t yet fully understand. The Asset Management Association of China has halted a fast-track channel for product registration for at least some quant managers and is urging them to submit more detailed monthly reports on trading activity and positioning, according to people familiar with the matter, who asked not to be identified discussing private information. A unit of China’s securities regulator is upgrading its monitoring models to better identify and track computer-driven trades, a person familiar with the effort said.
At the same time, some industry insiders have become concerned that the industry’s growth is making outsized gains more difficult to achieve.
Returns from so-called enhanced index products, a popular segment of quant funds in China, have dropped since mid-September and turned into losses in recent weeks, according to a report by analysts at China Merchants Securities Co. published Nov. 16. They noted a “significant” negative correlation between assets under management and excess returns. Assets managed by private quant firms jumped 60% this year through Sept. 30, according to Citic Securities Co. estimates, which are widely cited amid a lack of official data.
“Slower growth is unavoidable anyway as the industry moves into a more mature stage,” said Yin Tianyuan, head of research at Shanghai Suntime Information Technology Co., which tracks hedge funds. “Regulators do need to have a better grasp on quant trading after the rapid expansion, but I believe they intend to better develop the industry rather than restrict it.”
The China Securities Regulatory Commission didn’t respond to a request for comment.
CSRC Chairman Yi Huiman told a forum in September that although quant and high-frequency traders can improve liquidity and pricing efficiency, they can also lead to a confluence of trades that amplify market swings and cause unfairness. President Xi Jinping’s government has been increasing scrutiny of financial risks amid a sweeping campaign to make growth in the world’s second-largest economy more sustainable and equitable.
Six quant managers who spoke to Bloomberg on condition of anonymity said they don’t anticipate major government curbs on the industry, even if policy makers take steps to slow its expansion.
In a sign that at least some quant specialists still have scope to attract big money in China, Ray Dalio’s Bridgewater Associates last week raised more than twice as much as expected for a new private fund, bringing the firm’s onshore assets under management above 10 billion yuan ($1.6 billion), a record for a foreign-run firm.
Bridgewater, which obtained its China license is 2018, is pushing ahead from a lower base than Chinese rivals like Perseverance Asset Management and High-Flyer, while managing to differentiate its offering from other global heavyweights including UBS Group AG, D.E. Shaw and Two Sigma.
The dominance of retail investors in China, who tend to chase rallies and sell during periods of decline, contribute to volatile market swings that are fertile ground for computer models to profit from mispricing.
Market-neutral strategies at stock-focused private quants were able to deliver absolute returns above 10% every year since 2017 and 21% for last year, CICC analysts wrote in a report last month. Products that seek to enhance the returns of the smallcap CSI 1000 Index provided gains above the benchmark averaging nearly 25 percentage points since 2018, according to the report.
Yet performance data also show “clear convergence” in strategies, a tendency that has only become more pronounced this year, China Merchants Securities analysts wrote. That means quants could end up shifting portfolios simultaneously during a major market shift or when large redemptions occur.
Xu Shunan, founder of Inno Asset Management, said he expects growth in quant trading to continue over the next decade in China as the market’s inefficiencies allow higher returns than in more mature markets, even though beating the index will become more difficult over time.
While it’s unclear whether policy makers will tweak regulations for the industry, a “more desirable” scenario would be restrictions on high-frequency trading while staying supportive of other trading behavior, Li Minghong, a Shanghai-based fund of hedge funds manager at Aichen Asset, said in an interview.
“Whether quants can keep expanding their assets depends on their performance,” he said. “Capital chases profit.”
Bloomberg News
Wed, December 1, 2021
