China Quantitative Investment Funds Confront Increased Margin Calls Amid Chinese Stock Boom

The most significant rally in China's stock market in over a decade is exerting additional strain on the country's quantitative investment funds.

Investment firms that employ a market-neutral strategy, which includes shorting index futures, are encountering more margin calls as stock prices continue to rise, according to insiders told Bloomberg. The extent of these calls was generally less than on the previous Friday, when a trading malfunction made it more difficult for funds to secure additional funds, the sources stated, requesting anonymity due to the confidentiality of the information.

Some fund managers have informally indicated to regulatory bodies that they require additional time to fulfill margin call requirements, highlighting the degree of pressure they are under. A few have managed to meet the initial round of margin calls before the extended deadlines, thus avoiding forced liquidation.

These market-neutral strategies, which involve taking long positions in individual stocks while shorting stock index futures, typically experienced a decline of 3 to 5 percentage points last week, the sources mentioned. This downturn is an obstacle for quant funds that are still bouncing back from a market downturn in February.

A series of events—such as an unusual depletion of liquidity in the Shanghai stock exchange—triggered the turmoil on Friday, according to Liangkui Asset Management, which manages approximately 3 billion yuan ($428 million).

As brokerages enforced the closure of short index futures positions for clients who could not provide the necessary margin, it became "the last straw that broke the camel's back," the fund explained in a letter to investors, which was viewed by Bloomberg. Liangkui Asset reported an average drawdown of 1.5 to 2.5 percentage points, as stated in the letter.

This contrasts with a 13% increase in the benchmark CSI 300 stock index since Friday, marking the largest two-day rise since September 2008.

When the surge in index futures outpaced the gains in the underlying stocks on Friday, it resulted in paper losses for some quants' hedging positions, as per Liangkui Asset. As brokerages closed these short positions, they propelled the index futures even higher, along with investors speculating on further increases, exacerbating the short squeeze, it added.

The substantial premium is anticipated to decrease, which could enable quants to recover some of the unrealized losses on their hedging positions, according to some managers. China's stock index futures typically trade at a discount to the underlying indices, which is a crucial component of hedging costs in the market-neutral strategy. Their long-only strategies, such as enhanced index products, have been strengthened by the market rally.