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  • China quants lost 7.2% in January, versus gains in 2023
  • Quants threatened by short-trading curbs, small-cap drop

China’s deepening stock-market slump is even taking its toll on quantitative hedge funds, whose computer models have helped them outperform human traders at rival funds for the past three years.

Private quant funds suffered a 7.2% average loss in January, according to Shenzhen PaiPaiWang Investment & Management Co., underperforming the benchmark CSI 300 stock index, which dropped 6.3%. While traditional hedge funds fared even worse, it’s a far cry from quants’ stellar 4.9% gain in 2023, when China’s main equity gauge tumbled.

A recent slump in small-cap stocks and newly imposed curbs on short trading are posing fresh challenges for quants, which rely on algorithms to trade stocks, bonds and commodities. A rebound from the recent decline would further prove their resilience and attract investors frustrated by the more volatile performance of human traders.

“The market shifts in the past few years were much more rapid than usual, making life very difficult for active managers, while quants’ much more diversified portfolios can help capture returns,” said Eason Zhang, a money manager at quant firm Beijing X Asset Management. He expects the market to recover soon from the “extreme” slump. “The outperformance of quants will likely further improve their reputation.”

Chinese stocks on the mainland have lost about $5 trillion of market value from their peak in 2021, and a flurry of moves by regulators has so far failed to boost confidence. The government replaced the chief of the securities regulator this week, fueling hopes of more forceful steps to ease the declines.

Even veteran hedge fund managers have struggled as China stocks spiral downward. Shanghai Banxia Investment Management Center’s founder Li Bei slashed equity holdings last month, choosing to “lose an arm for survival.” Singapore’s Asia Genesis Management Pte closed its macro fund after wrong-way bets on Chinese and Japanese stocks, prompting its founder to say his “confidence as a trader is lost.”

Computer algorithms have helped quants fare much better. Five Chinese quants lifted assets above 10 billion yuan ($1.4 billion) each for the first time last year, according to PaiPaiWang, which tracks hedge funds. That included Beijing X, whose assets doubled to about 15 billion yuan after posting a 20% return on investments, Zhang said. All but one of the 32 funds in the top tier with at least 10 billion yuan posted gains in 2023, averaging a 6.4% return. That compared with a 3% loss for the active managers in the same size range.

Baiont Quant, a Nanjing-based fund that claims to be driven by artificial intelligence, topped the rankings for those running between 2 billion yuan and 5 billion yuan, with a 20% return. The company told investors in June that all its quant strategies are developed by AI, according to a transcript of a roadshow seen by Bloomberg. The company, backed by AI veteran Kai-Fu Lee, didn’t reply to requests seeking comment.

Chinese quants’ preference for smaller stocks and their ability to easily track thousands of listed firms helped them capture gains in recent years. At the same time, their use of hedging tools in market-neutral and other strategies protected them from the market declines that hit many of their actively managed, long-only rivals, according to Sun Bo, head of GF Asset Management HK.

Some of these strategies extended gains into January. The top 10 market-neutral products among managers running more than 1 billion yuan all returned at least 3% on the month, even as the index-enhanced products suffered, PaiPaiWang said in a Feb. 2 report.

“Quants are systematically better positioned” than active managers in these market conditions, Sun said. “In an environment today where even a 5% or 6% return is hard to get, no wonder they can attract investors.”

The gains are boosting market share for quant funds, which had combined assets of about 1.58 trillion yuan as of September, up 10% from two years ago, according to Citic Securities Co. As a sector, Chinese hedge funds’ combined assets rose just 3% last year to 5.7 trillion yuan, the brokerage said.

Long-only quant products attracted about 64% of last year’s new money, more than twice that of discretionary funds with the same bias, according to Citic Securities. The quant strategy generated 16.8 billion yuan of gains amid the market downturn, compared with 238 billion yuan of losses among rivals. The CSI 300 slumped 11% in 2023, and is down 2.6% this year even after surging this week on optimism over government support.

Still, heightened scrutiny threatens to erode profitability. Some quants this week were barred from cutting stock positions on some products as officials try to stem the market rout. Beijing has also been tightening rules for short selling, while commodities exchanges ended commission rebates on some programmed trades.

Quants’ exposure to small caps is adding pressure on returns. The CSI 2000 Index, which includes firms like Lotus Health Group, has tumbled 33% this year, reversing a 5.6% gain last year. Companies with market values of less than 11 billion yuan made up more than half of quants’ stock portfolios last year.

Despite these concerns, quant investing promises to gain more popularity among investors, with some discretionary funds already embracing AI, Beijing X Asset’s Zhang said.

“Most quant strategies also keep their positions full all the time, which is not a bad thing for the market” as the rout deepens, he said.

Written by: Bloomberg News — With assistance from John Liu and Dingmin Zhang @Bloomberg

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