Heavy retail attracts quantum funds to the Chinese markets

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Quantitative trading pioneer DE Shaw filed for direct access to China’s financial markets last month with little fuss. But when Chinese media discovered the mention of the move on a regulatory agency’s website, the news quickly spread.

“Another Quant-Titan invests in China” was the headline of the financial newspaper China Fund.

Perhaps no fund manager in the computerized quantitative investment industry could cause as much excitement in China as DE Shaw, the mysterious company founded in 1988 by retired computer scientist David Shaw that is now one of the largest and most successful hedge funds in the world.

The company declined to comment on its application to China’s Qualified Foreign Institutional Investor or QFII program, which enables direct trading in the onshore markets. However, one person familiar with the fund manager’s mindset said that regulatory reforms late last year and “growing market opportunity in China” made the application more attractive.

Quantum fund interest in China has exploded this year, according to fund managers and prime brokers in the region. Better instruments for hedging, easier access and more intensive trading by Chinese private investors, which create numerous opportunities for quantitative strategies to generate returns, are attracting the quant funds.

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

Previously, large hedge funds like those controlled by BlackRock and Man Group were less able to implement standard quantitative strategies in China. That has begun to change, particularly with the reforms last September that gave QFII investors access to derivatives, including some futures and options, and the lifting of the guidelines prohibiting speculative trading in financial futures contracts.

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

The ultimate draw for quants in China is the country’s private investors, who generate high sales in Shanghai and Shenzhen.

“There is a lot of systematic flow. . . because there are lots of local retail flows, ”said a European quant fund manager, while industry insiders point out the lack of sophistication among retail investors and frequent failure to conduct fundamental research that is easier for them to bet against. Zentific’s Lee cited the unorthodox strategies used by online retailers in the US earlier this year, describing the overwhelming number of Chinese retailers as contributing to a “Reddit times a hundred” market.

And while Quants could theoretically trade through Hong Kong’s stock connect programs with Shanghai and Shenzhen, by the end of 2020 those connections covered less than half of the companies trading on what is known as the mainland’s A-share market.

Hence a flood of applications from the likes of DE Shaw, who, despite their discretion in gaining QFII status last month, showed their interest in China by publishing a research paper on methods for calculating returns on Chinese stocks that resulted from prolonged trading stops were affected.

Foreign traders, especially hedge and quant funds, haven’t always felt so welcome in China. During a stock market implosion in 2015, authorities were quick to blame “malicious” short sales, particularly by foreign funds, before stopping short sales altogether.

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

Since then, overseas fund regulators have warmed. Beijing streamlined the QFII application process last November, admitting 156 new investors, official records show. The last 150 registrations before the overhaul were spread over a period of more than six years.

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But while the quants are serious about China, China is getting serious about the quants.

Speaking to the World Federation of Exchanges last month, Yi Huiman, chairman of the CSRC, cited quantitative trading as one of the “new challenges” facing China’s markets and warned that it would lead to “increased volatility, violations against market justice and other “could lead issues”.

The country’s financial press has also begun to deliberately question the impact of the quants during the recent boom in liquidity in onshore stock markets. A story in the state-run Securities Times last month cited unnamed local quants that foreign competitors referred to as “the incoming wolves.”

Despite those concerns, Bruce Pang, chief researcher at China Renaissance, contributed an estimated 10 to 20 percent of daily stock sales in China – the majority of which likely came from domestic funds. He added, however, that while Beijing encouraged “manageable” growth in quantitative trading, non-Chinese funds would remain vulnerable if markets weakened.

“If [regulators] If you want to blame someone, you have to blame the foreign quants because their local counterparts are still underdeveloped, ”Pang said.

Market veterans in Asia are aware of this. “[In China] You don’t want to be too innovative, ”said the hedge fund founder. “Postponing the envelope carries a higher risk.”

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