Intensive retailing attracts quantitative funds to Chinese markets

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Quantitative trading pioneer DE Shaw asked for direct access to Chinese financial markets last month with little fanfare. But when Chinese media spotted the mention of the move on a regulator’s website, word quickly spread.

“Another quantitative titan invests in China” headlined the headline of the China Fund, a financial newspaper.

Perhaps no fund manager in the computer-assisted quantitative investing industry could generate as much enthusiasm for entry into China as DE Shaw, the secret society founded by recluse computer scientist David Shaw in 1988. which is today one of the largest and most successful hedge funds in the world. .

The company declined to comment on its candidacy for China’s Qualified Foreign Institutional Investor, or QFII program, which allows direct trading in onshore markets. But a person familiar with the thinking of the fund manager said regulatory reforms late last year and “the growing market desirability in China” made the bid more attractive.

Interest in quantitative funds in China has exploded this year, according to fund managers and prime brokers in the region. Better hedging tools, easier access, and intensive transactions by Chinese retail investors, which create plenty of opportunities for quantitative strategies to generate returns, are all attracting quantum funds.

“A lot of people have been interested in the long bet on China, [including] growth in consumption and growth of the middle class, ”said Christopher Lee, chief investment officer at Zentific Investment Management, a hedge fund with quantitative strategies. “But recently what has changed is hedging and short selling is better.”

Previously, large hedge funds like those controlled by BlackRock and Man Group were less able to execute standard quantitative strategies in China. That has started to change, most notably with reforms last September granting QFII investors access to derivatives, including certain futures and options, and the removal of guidelines banning speculative trading in financial futures.

The founder of a Hong Kong-based quantitative hedge fund and industry veteran said there had been “a lot of interest” in China this year as the strong performance of some China-focused hedge funds , including quants, demonstrated “exploitable inefficiencies in the Chinese market.”

The ultimate attraction for quants in China is the country’s retail investors, which generate significant revenue in Shanghai and Shenzhen.

“There is a lot of systematic flow out there. . . because there are a lot of local retail flows, ”said a European quantitative fund executive, while industry insiders point to the lack of sophistication of retail investors and the frequent failure to conduct fundamental analysis that can make them easier to bet. Lee of Zentific, citing the unorthodox strategies used by online traders in the United States earlier this year, described the overwhelming number of Chinese retail traders as contributing to a market that was “Reddit times a hundred.”

And while quants could theoretically trade through Hong Kong’s equity connection programs with Shanghai and Shenzhen, those ties covered less than half of the companies trading on the mainland’s A-share market by the end of 2020.

Hence a flurry of applications from DE Shaw, who, despite all its discretion in seeking QFII status, made clear its interest in China last month by releasing a research paper on methods of calculating QFII status. Chinese stock returns hit by prolonged trading disruptions.

Foreign traders, especially hedge and quantitative funds, have not always felt so welcome in China. In a stock market implosion in 2015, authorities were quick to blame “malicious” short sales, especially by foreign funds, before stopping short sales altogether.

The China Securities and Regulatory Commission then spent years surveying the Chinese operations of Citadel Securities, the market maker controlled by US hedge fund billionaire Ken Griffin. Citadel Securities, which like Citadel’s hedge fund specializes in algorithmic trading, finally reached an agreement with regulators in early 2020, agreeing to pay 670 million Rmb ($ 104 million).

Regulators have since turned to foreign funds. Beijing streamlined the QFII application process last November and 156 new investors were approved, according to official documents. The last 150 approvals prior to the overhaul were spread over a period of more than six years.

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But as quants get serious about China, China gets serious about quants.

In a speech to the World Federation of Exchanges last month, Yi Huiman, chairman of the CSRC, named quantitative trading among the “new challenges” facing Chinese markets, warning that it could lead to “increased volatility. , breaches of market fairness and other issues “.

The country’s financial press has also started to question the impact of quants during a recent onshore stock market liquidity boom. An article in the Securities Times, a state newspaper last month, cited anonymous local quants who described foreign competitors as “the wolves that are coming.”

Despite these concerns, Bruce Pang, head of research at China Renaissance, estimated that quants in China accounted for a maximum of 10-20% of daily stock turnover, most of which likely came from domestic funds. But he added that if Beijing encouraged “manageable” growth in quantitative trade, non-Chinese funds would still be vulnerable if markets collapsed.

“Yes [regulators] want to pick someone to blame, they have to blame the foreign quants, because the domestic peers are still underdeveloped, ”Pang said.

Asian market veterans are well aware of this. “[In China] you don’t want to be too forward thinking, ”said the founder of the hedge fund. “Pushing back the envelope carries a higher level of risk. ”


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