(Bloomberg) -- A top Chinese quantitative hedge fund is shutting down its market-neutral products, exiting a strategy that saw widespread industry losses recently when a surge in local stocks squeezed their short positions.
Zhejiang High-Flyer Asset Management, which manages more than 50 billion yuan ($7 billion), told investors Friday that it would gradually cut all positions in such products to zero, saying future returns will notably fall short of investor expectations, according to a company representative who asked not to be identified discussing private information.
The Hangzhou-based firm said its decision to be “all in” long-only strategies was primarily based on its confidence in the prospects of China’s markets. High-Flyer has already been reducing the size of market-neutral products for two years, and its latest move will have little market impact because their remaining stock holdings have fallen below 1 billion yuan, the representative said.
China’s market rally last month added pressure on its quants, a 1.6 trillion yuan industry that’s been struggling to recover from a February meltdown and facing heightened regulatory scrutiny. Many managers recorded hefty drawdowns and rushed to meet margin calls to avoid forced liquidations in market-neutral products, after surging stock index futures imposed losses on their hedging positions.
China’s stock index futures surged in late September as the government’s economic stimulus package fueled optimism. Such gains exceeded a rally in underlying stocks, imposing paper losses on quants’ market-neutral products, which involve holding long positions in individual stocks while shorting index futures.
When brokerages closed some of the short positions by managers that failed to add margin, they pushed the index futures even higher along with investors betting on a further rally, worsening the short squeeze, according to Liangkui Asset Management.
The strategy gained popularity among institutional investors seeking more stable returns after regulators loosened restrictions on stock index futures in 2017. Hedge funds managed an estimated 129 billion yuan in such products, a small percentage of all their assets, according to a Haitong Securities Co. report in April.
Such products averaged a 2.7% drawdown in the third quarter, widening this year’s loss to 3.4%, according to Guolian Futures Co. High-Flyer’s market-neutral strategy lost about 1.8% in the final six trading days of last month, before recovering to a 0.7% gain in the first week after the National Day holiday, according to data seen by Bloomberg.
The China Securities Journal reported High-Flyer’s plans earlier.
High-Flyer, which has 98% of its assets in long-only strategies, already told investors Sept. 11 that its market-neutral products switched some positions to cash as lower market volatility reduced its return-to-risk ratio significantly, according to a notice seen by Bloomberg. The company didn’t face any forced liquidations as it held ample cash to meet margin calls, the representative said.
Still, some managers said earlier the premium in index futures was expected to narrow, which would allow quants to recoup some of the unrealized losses on the hedging positions. The Guolian analysts also recommended investors “moderately increase” allocations to the strategy in their report this month, citing an environment that can reduce hedging costs.
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