(Bloomberg) -- In China, Xiao Zhang’s two-year-old quantitative hedge fund has been a standout in an industry struggling with falling returns. Its meteoric rise is now being called into question after US prosecutors accused Zhang of stealing trade secrets from his ex-employer.
Zhang’s Pinestone Asset Management Co. shot to fame locally earlier this year as one of the rare winners from China’s “Quant Quake,” helping it more than double assets under management to 10 billion yuan ($1.4 billion) in a few months.
The Shanghai-based firm emerged relatively unscathed from a collapse in small-cap stocks in February that sent many rivals’ strategies haywire. Its head of trading said Pinestone’s “self-built” trading system protected it from the extreme market turbulence, enabling it to cut risk quickly and sail through the meltdown.
The US charges cast doubt on that claim. The federal grand jury indictment unsealed last week alleged that Zhang made copies of a global investment management firm’s code and projects, and that he misappropriated the information in order to use it at his own firm. The 33-year-old Chinese citizen has hired lawyers in the US and China, people familiar with the matter told Bloomberg earlier. Zhang and Pinestone haven’t commented on the allegations publicly. Pinestone declined to comment for this story.
The indictment adds to other cases brought by the US Department of Justice against Chinese nationals, who are alleged to have illegally exported technology or attempted to obtain software and source code from American companies or entities. Tensions between Washington and Beijing have been extremely high, and US authorities have long had concerns about technologies and intellectual property developed in America being used to benefit the country’s biggest economic rival.
It isn’t the first time a Chinese national has been accused of stealing trade secrets from a US quant firm. Nearly a decade ago, Gao Kang, a former New York-based analyst at Two Sigma Investments, was indicted on charges that he duplicated electronic-trading software from his former employer. Gao ended up pleading guilty and was sentenced to 10 months in prison. He subsequently returned to China and founded Yanfu Investments LLC, and has emerged as one of the biggest quants in China thanks to its solid performance.
The US Attorney’s Office in Massachusetts described Zhang as being “at large overseas.” The US doesn’t have an extradition treaty with China.
Zhang, who is Pinestone’s chief investment officer and largest shareholder, has been in meetings to appease clients and distributors of the firm’s funds, according to people familiar with the matter.
The allegations could also have ramifications for the broader Chinese quant and hedge fund industry, which has long prized managers with overseas experience. Many of China’s biggest quant funds have founders or key managers who previously worked at global firms including WorldQuant, Millennium Management and Two Sigma, according to data compiled by Shenzhen PaiPaiWang Investment & Management Co., which tracks Chinese hedge funds.
US Employment
Before starting Pinestone, Zhang worked for Arrowstreet Capital, a Boston-based quantitative investment firm focused on equities, from 2015 to 2021. His past employment dates matched the dates in the indictment, which didn’t name the global firm.
Zhang, who was also known as Sean when he lived and worked in the US, earned a master’s degree in financial economics from Columbia University in New York after graduating earlier from Shanghai University of Finance and Economics.
A testimonial on the American university’s website under Sean Zhang’s name said he worked for Arrowstreet. The Columbia program “armed me with the quantitative skills and broad academic knowledge that enabled me to develop a successful career in investment management,” it said.
Arrowstreet Capital, which was founded in 1999, had around $177 billion in assets under management at the end of last year, according to a regulatory filing. Its clients include pension plans, municipal governments, insurers, sovereign wealth funds and other institutional investors.
The firm uses proprietary quantitative models that draw from historical data and make predictions, and its research identifies, tests and incorporates investment signals into its return and risk models, the filing said.
A global equities portfolio that Arrowstreet manages for Calpers, the giant California pension fund, had a one-year total return of 25.9% and beat its benchmark by more than six percentage points, according to a Calpers performance report. That portfolio was worth $13.5 billion at the end of June 2024.
Pinestone’s other co-founder, Wu Que, also worked at Arrowstreet, according to local registry data in China. Zhang and Wu started building their model and trading system tailored to the Chinese stock market in September 2017, according to a brochure about Pinestone on PaiPaiWang’s website. It said Zhang used to have a senior position in Arrowstreet’s research department, and was in charge of developing models to predict returns, risk and the trading costs of global stocks.
The indictment described Zhang’s past job differently. It said he had been an associate at the global firm, and his “role was to provide support for particular research projects under the direction of more senior employees. Zhang did not develop research projects on his own.”
China Return
Zhang left the US and returned to China in August 2021, according to the indictment. That was also the final month of his tenure at Arrowstreet.
Around the end of the month, he allegedly used a virtual private network to access his former employer’s network, which enabled him to circumvent the company’s geoblockers, the document said. It said Zhang then made copies of the firm’s code and projects located in its code-management platform, and made copies of folders on the company’s internal research drive.
He then sent the information and items through a Chinese file-sharing app that enabled him to evade his former employer’s firewall, the indictment said. It added that the global firm was harmed by his actions.
Arrowstreet didn’t respond to requests for comment.
Pinestone has around 44 employees, about half of whom are in investment and research teams, according to a February company brochure. They include many graduates from top Chinese and foreign universities, according to a company roadshow. Wu was a gold medalist of the National Olympiad in Informatics in 2010, which sent him to the prominent Peking University directly.
The firm has stood out in an industry crowded with funds employing similar strategies. Pinestone instead focuses on “low-frequency trading strategies” that can help clients diversify allocations, and charges lower fees, Wu told the China Securities Journal in August. The firm’s core model also makes predictions on stock returns in the next month, allowing fewer transactions than rivals, Wu, who is also the firm’s general manager, was quoted as saying.
Pinestone’s assets are also mostly from institutional investors, including securities firms, unlike rivals who are more heavily reliant on retail clients.
The firm attributed its steady performance during the market meltdown earlier this year to tighter risk controls. Pinestone’s “optimizer” — which calculates the best positions in its portfolio — automatically reduced the leverage of its market neutral products in late January to 100%, from close to 300% in late December.
That deleveraging, which was triggered by indicators showing surging market risks, helped cap the largest drawdown during the market turmoil at 9% and allowed the firm to avoid force-selling assets, Chris Huang, director of trading, told Bloomberg in an earlier interview.
Outperformed Peers
The performance was exceptional among the so-called Direct Market Access products which sent many other managers scrambling to make changes manually. Pinestone’s funds earned an average 10.3% return in the first half of this year, according to PaiPaiWang. The firm’s asset growth also contrasted with the broader China quants industry, whose combined assets dropped in the first quarter.
In the US, the theft of trade secrets carries a sentence of up to 10 years in prison and a fine of as much as $250,000, according to the indictment.
For Pinestone, it’s too early to judge what might happen ahead of a verdict, said Li Minghong, founding partner of Shanghai Jiutouxiang Financial Information Services.
“Investors planning to invest might hesitate for the near term, while the impact on existing clients should be smaller — likely with small redemptions,” Li said. “People are still waiting for company statements, but more institutional investors may redeem if this escalates.”
Even if Zhang did copy codes, factors or methodologies from his former employer, Pinestone’s models should have incorporated adjustments and upgrades to adapt to the sharply different Chinese market, he said. The final impact on Pinestone “depends on how they resolve the dispute.”
The case may serve as a reminder to clients of other fund managers that had overseas work experience with rivals firms, Li said. “Do they have all the intellectual property rights on their models, or do they face infringement litigation risks? That can be very hard to tell.”
--With assistance from Bei Hu.
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