Hedge funds that deploy a basket of computer algorithms for trading are gaining popularity in China after many investors got burned by human stock pickers.
Firms including Shanghai Black Wing Asset Management Co. and Shanghai Minghong Investment Management Co. are among those ramping up multi-strategy quant offerings to tap growing investor demand.
A key sector underpinning quants’ out-performance has been equities, where managers generated a 10% return in six months to May 12, beating active funds’ 7.4% advance, according to Shenzhen PaiPaiWang Investment & Management Co. data of 110 stock-focused hedge funds managing at least 5 billion yuan ($700 million).
“Discussions about star managers have faded” over the past two years, Howbuy said in an April 27 report. “Investors are starting to develop a belief in quants while becoming skeptical toward active management.”
The disappointing performance of some of the best human-run hedge funds is adding to the notion that machines are better at navigating China’s often capricious markets. Quant funds are locked in an arms race to develop products based on multiple strategies, betting on investor interest as the market matures in the fashion of Western peers, where these strategies are becoming more accessible for pension funds and wealthy clients.
In China, local investors are looking for an edge after domestic stocks slumped, while uncertainty over the economy pushes more people to shift cash into overseas assets. China’s main equity gauge has gained just 1.5% this year, badly trailing most global indexes, after slumping 22% last year.
The out-performance of quants since last year has “put multi-strategy in the spotlight,” said Yi Weidong, general manager of custody at China Merchants Securities Co., the largest custodian for hedge funds. “Multi-strategy will become the next battlefield for fund managers.”
The automated trades are often based on a combination of quant strategies ranging from long only, which bets on stock gains, enhanced index bets, commodities, credit, and market neutral wagers.
| Quant types used in multi-strategy funds |
Details |
| Long-only |
A fund that holds onto stock positions. |
| Enhanced index |
The fund is usually benchmarked to an index and then modifies the weight of holdings or adds selective stocks. |
| CTA |
Invests in mostly futures and options focusing on commodity and currency markets. |
| Credit |
Funds that buy and sell fixed-income securities. |
| Market-Neutral |
Usually uses paired long and short positions or derivatives; often leveraged and high-cost. |
One such firm that has outperformed benchmarks is Shanghai Black Wing, which runs about 15 billion yuan.
It delivered a 2.7% gain last year after fees for its Selected Multi-strategy No. 1 fund that combines enhanced stock index and commodities trading. By comparison, the CSI Smallcap 500 Index, which the product tracks, slumped 20%. The total annualized return has been 23.5% since its April 2019 inception.
The company boosted the share of multi-strategy quant products to more than 50% of assets under management, with the majority of new inflows coming from high-net-worth individuals channeled via securities firms and banks.
“Multi-strategy is like the holy grail of quant investing,” Black Wing Chief Strategist Wang Jun said.
Competitor Shanghai Minghong is seizing the opportunity to raise money for its Multi-strategy No. 1 fund, which returned an annual 18.1% before fees since its inception in 2015. The company declined to specify a fund-raising target.
The product, which combines long-only, market-neutral, event-driven, and commodities strategies, has delivered gains every year.
“Multi-strategy is the best at sailing through bull and bear markets for the long term,” said Qiu Huiming, founder of Shanghai Minghong, which manages nearly $10 billion in assets.
The company is considering expanding its trading capacity by adding US stocks to further diversify its strategies.
Minghong has seen interest spike since last year, marking a change from the past when most deemed multi-strategy too complex and were unconvinced about its performance. Its clients now span from wealthy individuals who keep adding investments, to endowment funds from Peking University and Shanghai Jiao Tong University.
Inno Asset Management, which started multi-strategy offerings in 2015, added a new product line last year and expects to see a “relatively large increase” in their share in assets this year, founder Xu Shunan said.
Single Strategy
In good years, single-strategy products are able to capture bigger returns if the managers bet on the right stocks. That also means a bigger risk in down-cycles.
Actively managed long-only stock products averaged an almost 20% loss in 2022, with fewer than 5% of them making a profit, according to PaiPaiWang’s analysis of funds running more than 10 billion yuan.
Shanghai Panjing Investment Center, which manages more than 10 billion yuan, apologized to investors in December for steep losses after it was blindsided by China’s policy moves.
By comparison, multi-strategy quants can narrow losses in volatile years. These quants gained a total of 64% in the five years that ended 2020, according to PaiPaiWang. While that trailed long-only quants by about 6.8 percentage points, their biggest annual loss during the period — 0.2% in 2018 — was much smaller than the 12% decline by the more popular category.
After many were burned last year, Chinese retail and high-net-worth investors are starting to appreciate diversified strategies for sustainable returns.
“Multi-strategy allocations could iron out the volatilities and give investors a more stable experience,” said China Merchants’ Yi.
Globally, hedge funds that focused on multi-strategy, macro, and commodities strategies outperformed and most of them grew their assets last year, even as the top league’s combined size dropped 5%, according to a With Intelligence report on funds running at least $1 billion each. Citadel, one of the three multi-strategy firms among the top 10 managers, saw the biggest asset growth among the group.
Entry Barrier
The entry barrier for quants can be high. To perform well, hedge funds need data and coding expertise to produce algorithms for various types of strategies. Mingshi Investment Management, which runs about 150 million yuan of these products, divides its research like an assembly line into five areas — factors, artificial intelligence, optimization, risk control, and trading.
Others are trying to compete. Beijing-based Paradox Asset said in November it’s abandoning its focus on liquor stocks to embrace quants. Shanghai-based Minority Asset Management told investors in April it’s been increasing the use of computer models in stock selection for three years, managing to reap returns that beat benchmarks this year.
“As the Chinese market becomes more and more efficient, the reward-to-risk ratio of single strategies has declined significantly,” Inno Asset’s Xu said.
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