Chinese equities are notoriously volatile, meaning they can provide rich pickings for hedge funds but also carry significant risk. There are a number of reasons why Chinese equities are so volatile, including the dominance of retail investors.
China-focused hedge funds ride a roller coaster
The Chinese stock market, the second-largest in the world after the US, has experienced significant volatility since 2014, when the market opened to foreign investors, with periods of rapid growth swiftly ending in sharp corrections.1 Indeed, the Shanghai Composite typically experiences much greater volatility than the S&P 500.2 Over the past five years or so, for example, 10-day volatility for the CSI 300 index (which tracks the top 300 stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange) is almost double that of the S&P 500.
That volatility can provide rich pickings for hedge funds but also carries significant risk.
Why are Chinese equities so volatile?
A lack of transparency by Chinese policymakers has played a key role in stimulating volatility. They have instituted abrupt shifts in policy that have taken even seasoned investors by surprise. In October 2024, for example, Reuters reported that an abrupt and ferocious stock-market rally “slammed some of the country’s biggest hedge funds, forcing them to hastily cover short positions and take losses on their bets in the heavily regulated derivatives market”.3 The rally followed the announcement of an unexpectedly large package of stimulus measures by the government in September.
Some commentators believe the market is heading for a similar boom and bust to that seen in 2014 and 2015. Over the six months from 2014 to 2015, the Chinese stock market doubled in value, again following measures to stimulate the economy, with many local Chinese borrowing money to buy shares, cheered on by the state-run media. The Shanghai Stock Exchange reached a record high in June 2015, but then plunged, losing almost 40% of its value in a month, evoking comparisons with the 1929 Wall Street crash. The 2015 Chinese stock-market crash was precipitated by the release of draft regulations pertaining to shadow-financed margin accounts.
China's 2015/4 Boom and bust cycle set for repeat?
Hedge funds have also been affected by sudden direct attacks on some of their favourite tools by Chinese regulators. In July 2024, for example, regulators increased restrictions on short-selling, making the practice more difficult and more expensive.
“The steps, coupled with more explicit pledges to raise the costs of high-frequency trading, are piling up pressure on quants that have this year been hit by trading curbs and tightened ranging from fundraising to programmed trading”, reported Bloomberg.4
Retail dominance boosts volatility
The Chinese stock market also has some unique characteristics when compared with other global markets. It is relatively young and dominated by retail investors, who account for around 70% of volume, while professional investors account for around 80% of trades in the US, for example. Consequently, the Chinese market often behaves in a less rational manner than the US market, which is driven more by economic fundamentals. Chinese retail investors often trade on sentiment or as a result of rumours on social media, rather than company earnings or other financial news. Traders also often move in the same direction, causing wild swings in prices.5
A wild ride
Hedge funds have been active in China for many years and, reflecting the volatility of the market, some spectacular gains have been recorded. Hong Kong’s Triata Capital, for example, posted a return of 44% in September, taking its Jan–Sept performance to 56%. The $770 million China-focused fund held long-term investments in data centres, internet giants, e-commerce and travelfirms, and those investments bore fruit, according to Reuters.6 Similarly, back in 2015, China-focused hedge funds reported returns of around 25% in the first half of the year.7
Yet the losses suffered by hedge funds have also proved brutal. In September 2015, the Chinese hedge fund Shanghai Chaos Investment Co. apologised to investors for the losses it experienced following the 2015 market crash. The company’s flagship Chaos Number 1 Value Fund plunged 37% in just two weeks in August 2015.
The September 2024 rally has also caught out some experienced investors. In October, the hedge fund Shanghai Power Asset Management Co. apologised to investors and shut its arbitrage strategy after heavy losses, “the latest China hedge fund bruised by wild gyrations in the market since authorities vowed to support the economy and hit growth targets”, according to Reuters.8
Given that retail investors show no sign of loosening their grip on the market, and Chinese policymaking is unlikely to become any less transparent in the near future, Chinese shares are likely to remain highly volatile, creating the potential for further rich rewards… and losses.
Sources
1 https://www.sinorbis.com/understanding-the-chinese-stock-market
2 https://www.scirp.org/journal/paperinformation?paperid=98782
3 https://www.reuters.com/markets/asia/china-hedge-funds-caught-out-by-abrupt-market-surge-2024-10-17/
4 https://www.bloomberg.com/news/articles/2024-07-11/quant-hedge-funds-dealt-fresh-blow-from-china-s-short-sale-curbs
5 https://www.youtube.com/watch?v=62UmvP3E2VE
6 https://www.reuters.com/markets/asia/china-focused-hedge-funds-post-explosive-september-returns-2024-10-04/
7
https://www.caymancompass.com/2015/06/10/china-hedge-funds-rally-25-percent-in-2015/
8 https://www.reuters.com/markets/asia/chinas-market-rollercoaster-claims-another-fund-2024-10-25/
Data di pubblicazione:
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
All trading involves risk to capital.
Contact us
Let us create a solution tailored for your needs. Get in touch with our team by phone or email to discuss your objectives, or request a brochure.