China’s quantitative hedge funds, which have consistently outperformed in recent years, are struggling to keep up as the government’s recent economic stimulus has triggered a surge in local stocks that has strained their models and short positions, according to a report by Bloomberg.
The report cites data from Shenzhen PaiPaiWang Investment & Management Co as showing that in September, Chinese quants’ long-only strategies underperformed the mainland’s 22% stock market jump by roughly 2 percentage points, flipping their year-to-date returns into a slight 0.1% loss. This marks a stark contrast from their typical performance of 16 percentage points or more above the market over the past three years.
Market-neutral strategies, designed to generate returns while controlling for volatility, fell 0.8% in September, adding to a year-to-date loss of 2.5%. These strategies have been consistently profitable over the past four years, according to PaiPaiWang, but this year’s volatility is testing their resilience.
Quants’ inability to capitalise on the market upswing in September follows significant losses in February, when small-cap stocks — often favoured by quantitative models — saw steep declines. These setbacks are threatening to erode investor confidence in China’s RMB1.6tn ($225bn) quant industry, known for its promise of outperformance, just as regulatory scrutiny is tightening.
Quant funds in China typically use multi-factor models that identify favourable traits among listed companies, often leading to an over-concentration in small caps. Managers have traditionally accepted some deviation from benchmarks in their index-enhanced products. However, when small-cap stocks plummeted in February and major indices climbed in response to government support, quants’ returns turned negative in what Edward Liu, CIO at Shanghai Manfeng Asset Management, described as an industry “Waterloo.”
To mitigate these losses, many quant funds rebalanced their portfolios to track rising indices, creating a rush to exit small caps and fuelling a “perfect storm.”
As markets rallied again in late September, quant portfolios — often more diversified than their benchmark indices — were unable to keep pace with broad index gains. Their market-neutral products suffered significant losses as index futures rose, increasing losses on short positions.
While February’s losses were partly attributed to quant funds’ own risk management, the unpredictable market swings in recent months defy traditional quant models trained on historical data.
China’s CSI 300 Index surged 27% in late September, buoyed by government stimulus measures. It continued with a 6% gain at the start of October before falling over 8% as investors awaited more clarity on fiscal policy.
Despite these setbacks, quant funds outperformed discretionary stock hedge funds in September, as they maintained fully invested positions while other funds rebuilt their portfolios from low levels. Additionally, some of the top quant performers began to recover their returns as the market volatility eased in early October, per data from PaiPaiWang.
