CICC looks to China assets for alt risk premia boost

Source of diversification can be found in yuan-denominated assets, says fund’s quant head

Shanghai from the air

As alternative risk premia strategies struggle globally, China International Capital Corporation’s asset management unit is turning to mainland assets in a bid to reduce correlation and potentially enhance returns.

For its maiden alt risk premia fund, the Hong Kong-based arm of the firm intends to allocate 10–20% of investments to onshore China assets by March from nothing now, says Qilong Zhang, head of quantitative strategies at CICC Hong Kong Asset Management. The $49 billion manager says the relaxation of regulatory barriers could help it tap mainland commodity futures as well.

The push into onshore assets comes as the fund prepares to open up to external investment later this year. The strategy, which began in August 2018, is currently seeded with the company’s own funds.

“The partially insulated nature of Chinese markets is appealing in the perspective of portfolio construction as it brings down correlation of the entire portfolio,” Zhang says. “The yuan-denominated markets operate in a discrete market behaviour and price discovery mechanism as opposed to the rest of the world.”

Zhang hopes that diversifying will help protect the fund from the threat of drawdowns when “fat tail” risk events strike. Last year saw a series of setbacks to investment managers: the Vix blow-up in February, a value-stocks slide in the early summer, emerging market turmoil in August, market reversals in October and the tech disruption in December.

Against this backdrop, alt risk premia strategies suffered and returns slumped. The Clear Alpha Global Index – a performance benchmark for bank investable indexes – lost more than 4% in 2018.

Qilong Zhang
Qilong Zhang, CICC Hong Kong Asset Management

But Zhang says CICC’s belief in the long-term rewards derived from alt risk premia remains intact. The rationale for the fund’s foray into China-listed assets is the “effective diversification” provided by markets where retail investors are dominant, Zhang explains. In China’s equity market, for example, retail investors account for 80% of turnover and fifth of the total market capitalisation, according to the annual statistics released by the Shanghai Stock Exchange.

The behaviour of retail investors causes asset prices to move in a way not mirrored in other developed markets, where institutions make up a larger share of the investor base. This idiosyncrasy is expected to persist as the involvement of global institutional investors in China’s markets is still confined to a limited number of “connect” programmes – Stock Connect and Bond Connect – from offshore centres such as Hong Kong.

Spreading the word

Asia’s investment houses have been slow to adopt alternative risk premia strategies. Alt risk premia products offered by investment banks account for $320 billion in assets globally, according to asset management consultancy MJ Hudson. That compares with $50 billion across Asia-Pacific, with Japan and Australia dominating in the region, banks say.

Commenting on CICC’s plans to open up its alt risk premia fund to institutional investors and family offices this year, Zhang says this client base is better equipped to understand the strategy than retail investors, many of whom believe alt risk premia is purely an absolute return strategy that only yields positive returns.

He sees investor education as an ongoing challenge for CICC, and the industry as a whole, although there is cause for optimism.

“The trend is promising,” Zhang says. “We observe more mainland high-net-worth investors becoming sophisticated as they care more about risk-adjusted metrics of their investment return and the scientific evidence of complex investment philosophy.”

CICC expects China’s crackdown on shadow banking products, which have long attracted mainland investors thanks to the promise of almost guaranteed returns, could lure family offices and non-financial corporations to invest in alt risk premia.

Zhang declined to comment on the assets the strategy currently manages or the specific timeline for opening up to other investors. The alt risk premia fund is targeting a 5% return over the US fed funds rate on a volatility of 5%. The China assets will be key to hitting this return profile, CICC believes.

The principal objective of an alt risk premia fund is to invest in long and short strategies that yield above-average returns, using factors such as carry, momentum and trend-following. CICC intends to restrict the number of strategies it uses to a maximum of 10, to limit cost and the derivative contracts that need to be managed. The factors are selected from the 300-plus strategies documented in academia.

“Each strategy requires ongoing research and due diligence to ensure that we are informed about the risk the portfolio is exposed to and how the factors behave under changing market conditions,” Zhang says.

The relaxation in the futures market is expected to create a less costly playground for market-neutral product providers like us

Qilong Zhang, CICC Hong Kong Asset Management

The fund’s assets are managed partially by algorithm, with human intervention in a few key areas.

“We describe to investors that our alternative risk premia platform has a semi-active management style: human analysts are responsible for strategy selection, portfolio construction and risk management of the systematic product,” Zhang says.

The portfolio is split into defensive, carry and long/short equity strategies. The defensive bucket will now include China commodity futures benchmarked to a momentum indicator that bets on a sustained rise or fall in prices. Carry strategies include foreign exchange carry and credit spread. Long/short equity strategies focus on long positions of single stocks that are hedged by shorting index futures. The portfolio is rebalanced every quarter.

“The commodity contract is a major element in the defensive part of the proposed portfolio and serves as a replacement for bonds to generate income,” he says.

The overall China allocation will also comprise five- and 10-year China government bond futures and CSI 300 index futures.

Assets allocated globally track indexes provided by three global investment banks. Zhang declined to name the indexes or the banks.

Removal of some regulatory barriers could also help CICC’s China commodities investments.

“We started a conversation with mainland financial regulators concerning the cross-border trading arrangement for commodities future contracts specifically for the overseas assets,” Zhang says. This will allow CICC to transact commodity contracts for overseas clients’ assets in the alt risk premia accounts.

Currently, there is no equivalent to the “connect” schemes to enable foreign investors to access onshore commodities futures. Zhang predicts that the regulator will continue to allow more trading activities in the futures market, following the opening up of index futures trading in December 2018. “The relaxation in the futures market reduces the cost of hedging and is expected to create a less costly playground for market-neutral product providers like us.”

Inclusive onshore access will take time, though. An alternative way is to mimic a regular futures contract instead. CICC plans to use total return swaps, where it will pay a fee to an onshore bank or securities house to receive cash based on the performance of the mainland’s futures market, he says.

The synthetic exposure involves another layer of cost but Zhang describes the additional fee to be “manageable and reasonable”.

Correction, January 29, 2019: The original version of this article stated the alt risk premia strategy began in 2017. It actually began in August 2018.

Editing by Alex Krohn

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