A group of systematic investors betting on large Chinese companies has emerged largely unscathed from this year’s “quant quake” that’s sparked turmoil in the stock market and a crackdown by regulators.
Rules-based funds investing in large stocks have weathered the equity storm as blue-chip companies outperformed on haven demand and buying by state funds. In one lens into the opaque world of quantitative trading, a Bloomberg-compiled portfolio that makes long and short bets on Chinese large caps has gained about 11% this year through Thursday, after posting the best month since 2014 in January.
It’s a different story for quant traders riding small-cap firms, who found themselves at the center of the market selloff. Even after bouncing back from the early February lows, the CSI 2000 Index of small stocks is still down 15% this year, while the large-cap equivalent is up 3%.
“The mega-cap has done really, really well versus the small-cap — that’s probably the biggest performance differential,” said Jason Hsu, founder of Hong Kong-based Rayliant Global Advisors Ltd., which oversees about $20 billion, including $3 billion in Chinese onshore shares.
The divergent returns underscore how small-cap strategies bore the brunt of the pain during the massive plunge in Chinese equities over the first five weeks of the year. Funds making small-cap bets, which had been in vogue after their 2023 outperformance, were caught off guard when the market suddenly shifted, prompting quant products with heavy exposure to trim holdings further.
Concerned that quant funds were exacerbating declines, regulators then imposed a slew of restrictions, including trading limits at the start and end of the day, along with caps on leverage and increased scrutiny of trading strategies. The Shanghai and Shenzhen stock exchanges even took the unusual step of freezing the accounts of a major quant fund for three days after it dumped about $360 million in shares within a minute at the market open.
Making matters worse for these funds, China stepped in to buy large stocks and exchange-traded funds via the “national team” of state-owned entities, leaving small caps behind. The turmoil has drawn comparisons to the “quant quake” that throttled US managers in 2007 ahead of the global financial crisis.
“The ‘quant quake’ was, in reality, a result of over-exposure in the market to the small-mini cap sector, primarily affecting short-horizon quant strategies that had significant exposure to the space,” said Hanqing Tian, who oversees quant portfolios at Huatai-Pinebridge Investments.
For its mid- and large-cap trades, Huatai-Pinebridge is deploying fundamental factors like value and quality. Its small-cap portfolios meanwhile, are focused on short-term technical signals, which work better in a segment driven by investor behavior and with little analyst coverage, Tian said by email.
The US-listed Rayliant Quantamental China Equity ETF, which uses a model with more than 100 signals, has topped the main CSI 300 index by 2 percentage points in dollar terms this year. Quant powerhouse AQR Capital Management’s Chinese A-share portfolios trading mid- and large-caps have also gained this year, according to a person familiar with the matter who declined to be identified as the information is private. A Robeco fund focused on low-volatility Chinese shares has outperformed with a roughly 5% gain this year.
Value Trades
Money managers say the recent bout of risk aversion in China benefited the traditional factors that tend to drive stock performance. The value trade — buying cheap over pricey shares — has favored Chinese large caps seen as relative havens. The low-volatility bet prefers steady names, while the momentum strategy of buying recent winners has ridden these trends after a protracted downturn.
Putting it altogether, the Bloomberg multi-factor model gained about 24% in January, followed by a 11% loss last month. The model imitates how a quant fund might dice and slice the market based on the widely used value, momentum, low volatility and profitability factors.
At PanAgora Asset Management Inc., George Mussalli, chief investment officer for equities, says his exposure to China A shares has held up “reasonably well,” led by the quality and momentum factors.
Still, even with the small cap selloff in January, it will be hard for many Chinese quants to move away from the sector since their models are tailored to that market, Rayliant’s Hsu said.
“It’s more inefficient, so the alpha’s larger,” he said, referring to the potential for gains above the benchmark. “So I think most of them go, ‘look, we’re going to get hit once in a while,’ but it’s not big enough to shift their product strategy.”
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