Quant hedge fund 'free fall' spooks wealthy investors in China

Bloomberg

Jul 21

For China's newest quant-fund enthusiasts, two weeks were all it took to discover the downside of a sector that had seemed almost unstoppable.(July 21): For China's newest quant-fund enthusiasts, two ...

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The euphoria has quickly faded, with net asset values at some funds tumbling more than 20% and wiping out months of gains.\n\"It felt like a free fall,\" said Wang, a 38-year-old software engineer in Shanghai who invested one million yuan in a fund managed by Shanghai Wenbo Investment Management Co in October. \"One moment I was flying high and the next I was back down.\"\nThe losses mark one of the worst setbacks for China's quant fund industry in years, rattling affluent investors who had flocked to market-neutral and index-enhanced strategies as one of the few bright spots during the country's property downturn and prolonged equity-market malaise.\n\nIn recent weeks, a chorus of hedge funds began pointing to the risks of an AI bubble triggering a sharp market reversal. Many quants were caught off guard, with the selloff hammering some of the industry's biggest names. One fund at DeepSeek founder Liang Wenfeng's Zhejiang High-Flyer Asset Management plunged nearly 16% within a week.\nQuant funds were hit by a rotation that saw investors abandon small- and micro-cap stocks in favour of large benchmark names. Many quant models, which had been positioned for the previous market regime, were slow to adjust and suffered losses as their favoured factors turned against them.\nThe pain was amplified by crowded positioning: as funds rushed to cut exposure to the same stocks, selling pressure deepened declines and triggered further deleveraging across the market.\nThe 73 quants' products seeking to beat the CSI 1000 Index of small-cap Chinese stocks fell an average 14% last week and trailed their benchmark by an average 1.9 percentage points, according to returns compiled by a fund distributor who asked not to be named because the figures are private.\nJoe Zhou, a high-net-worth investor who parked 20 million yuan with BlackWing Asset Management, said he's seen his investment with the stock strategy dip nearly 30% in the past few weeks, one of the biggest declines since its formation, according to a report for investors.\n\"It's like being on a roller coaster,\" Zhou said, adding that he does not think this is a good time to allocate more to quants or get into the Chinese A-share market because of potential forced selling.\nBlackWing's stock strategy lost 19.39% in net asset value in the week ended July 17, the biggest decline since its formation, according to a report for investors.\nBlackWing said such industrywide drawdowns were primarily triggered by external risks rather than evidence of model decay. The firm expects both its fund net values and excess returns to recover as markets stabilise, it said in a response to Bloomberg enquiries.\nShanghai Wenbo won't abandon investment principles that have proven effective over the long term, founder Zheng Yao said. It will use more scientific, intelligent and advanced approaches to build better investment portfolios, he said.\nStocks rebound\nThe CSI 1000 fell more than 12% last week, the most since a bout of market turmoil that hit quants in February 2024. The gauge rebounded on Tuesday, part of a broader rally as Chinese authorities and state-backed investors moved to shore up confidence.\nChina's STAR 50 Index jumped almost 11%, its biggest one-day advance since October 2024 while the Shenzhen-listed ChiNext Index rallied more than 7%.\nQuants are attributing the sharp drawdowns to an abrupt reversal in the market's most crowded trades, according to reviews of 21 managers compiled by Shenzhen PaiPaiWang Investment & Management Co, which tracks hedge funds. Tech and high-momentum growth stocks, which had led gains earlier in the year, sold off rapidly as weakness in such shares overseas spread to China. Falling margin-financing balances, forced deleveraging and broader risk aversion intensified the decline.\nFor Li Minghong, investment director at E Tiger Private Fund Partners LLC, a fund of hedge funds, the selloff was more like the result of a feedback loop that had been building for months. Li said similarities in exposure and strategies turned the AI selloff into an industrywide collapse in excess returns.\nSince early 2026, strong performance from momentum and beta factors led both traditional and machine-learning models to assign them greater weight, Li said. That pushed more quant money into the same AI-linked small-cap stocks, reinforcing an increasingly crowded rally.\nAs valuations rose, fresh inflows from high-net-worth investors began to dry up, leaving the market with less incremental buying power. A sharp drop in overseas AI shares then became \"the straw that broke the camel's back\", triggering redemptions and forcing quant managers to cut positions, Li said.\nRegulators met with eight investor representatives on Monday to gather views on supporting the stable development of capital markets. Authorities pledged to strengthen risk prevention and enhance oversight while investors sought steps to attract more long-term capital and tighten scrutiny of quantitative trading and AI-related applications.\nChina's five largest insurers also pledged support for capital-market development, the Securities Times reported.\n'Never expected'\nThose moves offered little comfort to investors already nursing steep losses. For Min Chen, the experience has been even more painful. The 32-year-old Shanghai resident invested one million yuan in a quant fund managed by Ningbo Alpha2Fund Investment Management Partnership Enterprise in early July, making her first allocation to the sector. Within two weeks, the product had fallen nearly 19%.\n\"I bought it because I was told it could generate stable returns regardless of market direction,\" Chen said. \"I knew there would be volatility but I never expected this kind of move.\"\nChen has already decided to redeem her investment, calling it a lesson in following market hype without fully understanding the risks.\nAlpha2Fund said the market downturn was driven by a liquidity shock rather than a shift in fundamentals and A-share valuations have come back to a \"relatively reasonable range\". The company is confident in the market and its own strategy, it said, citing an announcement on Sunday that it is buying its own products with proprietary money.\nEven seasoned investors are being tested. May He, a Hangzhou-based manufacturing business owner who has invested more than 50 million yuan in market-neutral quant strategies for years, is contemplating redeeming part of her holdings after losing several million yuan on paper within days.\n\"Almost no one has been spared,\" said He.\n'Stress test'\nPortfolio managers are considering their next steps. Ningbo Lingjun Investment Management Partnership said the biggest near-term risk for global markets is corporate earnings from AI companies, with disappointing results potentially triggering a broader correction at a time of divided investor sentiment.\nWhile Lingjun Investment remains convicted on AI stocks, it says the lesson is to diversify into lower-correlation assets, including commodity trading advisor funds and quant strategies focused on China's A-share market. It also warned that elevated leverage across major economies remains a key risk for global investors.\nQuants' momentum-driven strategies are inherently pro-cyclical, amplifying market swings, E Tiger's Li said. With effective oversight, they can contribute to a sustained bull market; without adequate constraints, they risk fuelling speculative excess.\n\"This drawdown is a stress test for the quant industry's boom period and a risk-education moment for both markets and regulators,\" Li said. \"The quant boom is not over but the easy-money phase is.\"\nUploaded by Arion Yeow","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":false,"editions":null,"column":"","sentiment":"-1","news_tag":"","news_rank":0,"isVideo":false,"video":null,"symbols":[],"gpt_button":0,"need_auth":false,"need_login_tip":false,"code":"91000000","status":"200"}}}