Photographer: Andrey Rudakov/Bloomberg

Quant Hedge Funds Are China's Hot New Export

  • XY, Huatai-PineBridge, Co-Fund are all setting sights overseas
  • Deutsche Bank won 10 offshore mandates from Chinese managers

Add China’s quant shops to the list of hedge funds branching out across Asian markets.

Quantitative money managers from the world’s second-largest economy are opening offshore funds at a never-before-seen pace, according to Marlon Sanchez, the Asia-Pacific head of prime finance at Deutsche Bank AG. XY Investments, founded by an alumnus of Cliff Asness’s AQR Capital Management, and Co-Fund Co., led by former BNY Mellon Western Fund Management Chief Executive Officer Hu Bin, are among firms that started or plan to start trading in markets from Hong Kong to Singapore and beyond this year.

"This is the biggest wave of Chinese quant firms expanding offshore that I’ve seen,” said Sanchez, who’s lived in Hong Kong since 2002, before hedge funds emerged from the regulatory grey area of China’s financial system. Deutsche Bank has won 10 mandates to provide prime brokerage services to new quant funds managed by China-based firms so far this year, Sanchez said in a phone interview.

While the motivation to expand outside China varies from firm to firm, several developments help explain the trend. For starters, the country’s yearlong clampdown stock-index futures trading has wreaked havoc on domestic quant managers who need the contracts to hedge. At the same time, demand for offshore funds is growing as the pool of overseas Chinese wealth increases and international institutions boost allocations to computer-driven strategies.

Chinese quants are expanding just as some of the biggest global investors devote more resources to Asia. The country’s own $814 billion sovereign wealth fund said this month that it may increase hedge fund investments in the region, while Point72 Asset Management, Balyasny Asset Management and Folger Hill Asset Management are all adding Asia-based offices and staff, seeking new sources of return from markets viewed as less crowded than those in the U.S. and Europe.

For now, the proliferation of China-based quants is unlikely to prove a major competitive threat for global funds flocking to the region. Most Chinese managers are starting out small, with XY receiving about $35 million of capital commitments for a Cayman Islands-incorporated fund that will bet on rising and falling stocks in Asia. The firm, run by Tony Tang and his wife Cindy Zhou, currently oversees the equivalent of about $300 million for onshore Chinese clients.

But Tang has big ambitions to grow in China and abroad, using the same type of scientific research approach that earned AQR widespread recognition.

"We saw what AQR can accomplish in about 20 years, and we want to duplicate that," he said of his former employer, a $159 billion giant co-founded by Asness in 1998.

For a related story on hedge funds expanding in Asia, click here.

While achieving that kind of scale is rare in the hedge fund industry, conditions look ripe for Chinese quants to attract domestic and overseas money. Their countrymen have been shifting assets offshore at an unprecedented pace, with capital outflows over the past 20 months swelling to an estimated $1.47 trillion as domestic economic growth slowed and the yuan weakened.

Home-grown managers are better positioned to attract those assets than international peers, said Zhou Xin, an analyst at Suntime Information Technology’s unit, which tracks China’s local hedge fund industry.

"Investors are more familiar with domestic fund managers,” Zhou said. “There is the perception that if something goes wrong with the investment, it’s much easier to seek recourse.”

Margin Requirements

The difficult trading environment in mainland markets has given Chinese quants an added incentive to go overseas. Domestic equity-index futures volumes have plunged 99 percent since August 2015 after policy makers tightened position limits and lifted margin requirements to deter speculators in the wake of last summer’s equity crash. That in turn has hampered so-called market neutral quant funds, which use the contracts to hedge against index swings.

A typical market neutral strategy might involve selling futures and buying shares of individual companies that the manager (or her computer) predicts will beat the index. If she bets right, the fund profits from picking outperformers while limiting exposure to market volatility. Because China’s infrastructure for short selling and options trading is still relatively limited, the futures market had been the go-to place for quantitative funds in need of a hedge.

Turning Point

The regulatory clampdown’s impact has been severe. After returning 25 percent in the first half of 2015, China’s onshore market neutral funds lost an average 0.9 percent in the same period this year, according to Shanghai Suntime. XY’s domestic funds are flat or posting single-digit gains in 2016 after returning 30 percent to 40 percent last year, according to Tang. 

“Last August was really a turning point for a lot of hedge funds in China,” he said.

To be sure, policy makers could quickly revive the futures market by rolling back trading curbs. China’s futures exchange is considering allowing a 10-fold increase in position limits on certain accounts, while also reducing fees and margin requirements, people familiar with the matter said in August. The proposals have yet to be finalized and any new rules would require approval from the China Securities Regulatory Commission.

As for opportunities in Asia, the region is hardly an oasis of easy returns. While Asian hedge funds outperformed global peers every year from 2012 to 2015, they’re lagging behind in 2016, according to Eurekahedge. Investors redeemed $13.7 billion from Asia-focused funds this year through August, or 12 percent of regional assets, data from eVestment show.

Yet computer-driven strategies have remained popular. A Eurekahedge index of quant hedge funds in Asia has climbed 2.4 percent this year, versus a 0.3 percent gain in the firm’s broad regional index. More than two-thirds of investors in a hedge fund survey released by Deutsche Bank in February invested in quant strategies, while half of them planned to increase allocations this year.

Asia-focused quant funds have beaten global peers in all but one year since 2005, according to Eurekahedge, lending credence to claims that the less efficient markets in the region are potentially more lucrative for savvy managers. In the first eight months of this year, gains in Asia beat the 1.8 percent global average return for quant funds, according to the Singapore-based data provider.

Among firms seeking to tap into that demand is Huatai-PineBridge Investments, the China venture of Hong Kong billionaire Richard Li’s money-management company. Huatai-PineBridge, whose quantitative team oversees about 5 billion yuan in onshore long-only portfolios and hedge funds, will advise on a new market-neutral fund that trades stocks in major Asian markets, according to Deputy General Manager Tian Hanqing, a former Barclays Global Investors fund manager who returned to China from the U.S. in 2009. The fund starts trading on Friday, Tian said.

New Futures

CICC Investment Solution, a private fund manager led by Kan Rui, will advise a global market-neutral stock hedge fund, according to a person with knowledge of the matter who asked not to be identified. Kan, the firm’s Beijing-based chief investment officer, was previously a senior strategist with U.S.-based quantitative asset manager Susquehanna International Group and CEO of China International Capital Corp.’s mutual fund unit.

At XY, the offshore fund will focus on Greater China-related investments during its first one or two years, using index futures in Hong Kong and Singapore to hedge market risk, Tang said. Co-Fund trades Singapore-traded FTSE China A50 contracts in its offshore vehicle, according to documents posted on the firm’s website. CICC Investment Solution’s fund will initially buy and short Hong Kong-listed stocks before gradually expanding to the rest of Asia, Europe and the U.S., according to a person with knowledge of the firm’s plans.

"Global investors looking at regional allocations see China quant funds as an opportunity," Deutsche Bank’s Sanchez said. "As an asset class, it’s proving itself with real money investors.”

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