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Quant Fund Meltdown in Mainland China: A Lesson in Liquidity and Risk

Quant Fund Meltdown in Mainland China: A Lesson in Liquidity and Risk

Trading and Investing / China

In the last weeks, the financial sector in mainland China witnessed what can only be termed as a ‘meltdown’ among quantitative funds.

Moreover, this tumultuous period became characterized by significant drawdowns!

With an average weekly loss nearing 7%. In some extreme cases, certain funds have plummeted by as much as 20% to a staggering 80%, especially those employing leveraged Direct Market Access (DMA) strategies.

The core of this crisis lies in a widely adopted strategy that involved long positions in micro-cap stocks, counterbalanced by hedging through middle to large-cap futures. This approach seemed promising initially, especially considering the micro-cap stock index’s 80% surge last year, in stark contrast to the major index’s 10% decline. However, this success story harbored an inherent flaw – a substantial liquidity risk within the sector.

As the new year dawned, pressures mounted on stocks, leading to a dramatic reversal in the micro-cap sector.

Micro-cap stocks, which had been on an upward trajectory, began to plummet. Compounding the issue, large-cap futures experienced an uptick, largely attributed to government interventions that included purchasing large and middle-cap ETFs. This divergence between the micro-cap stocks and large-cap futures triggered a panic among investors, leading to a ‘stampede’ effect. The ensuing chaos saw the micro-cap index plunge by over 10% daily for four consecutive days.

The aftermath of this turmoil was devastating for nearly all quantitative funds in the region. Leveraged funds were particularly hard hit, with some facing complete insolvency. Even top-tier large funds, boasting over 10 billion RMB in Assets Under Management (AUM), were not spared, suffering drawdowns exceeding 10%.

In conclusion, this event underscores a critical lesson: market-neutral strategies are not inherently low-risk.

Thus, sacrificing liquidity for such strategies can lead to severe repercussions. Lastly, this episode in the financial markets of mainland China likely will serve as another cautionary tale. This one about the delicate balance between strategy, liquidity, and risk in the volatile world of quantitative fund management. For more reading on understanding such risks we recommend reading our favorite Italian mathematician Dr. Paleologo’s Advanced Portfolio Management!

Quant Fund Meltdown in Mainland China: A Lesson in Liquidity and Risk