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A revival appears to be underway for China investing mandates in 2017 following disappointing returns last year. The recent decision by MSCI to include Chinese A Shares in its broader Emerging Market Indices is likely to support this trend, though exposure through long-only type vehicles to underlying markets could take investors for a ride given the inherent volatility. This piece looks at the performance of China A-Share investing hedge funds and how they have managed to ride the volatility in underlying markets over the years.

The Eurekahedge China A-Share Investing Hedge Fund Index, which tracks the performance of 38 hedge fund managers that carry exposure to China’s A-shares stocks is up 10.33% in the first half of 2017. This compares with returns of 2.89%, -3.63% and 10.78% for the Shanghai A Shares Index, the Shenzhen Composite Index and the CSI 300 Index. Meanwhile the average global hedge fund has posted gains of 3.25% in the first half of the year.

Figure 1 depicts the relative outperformance of the China A-Share Investing Hedge Fund Index versus the Shanghai A Share Index. Over the 90 month period shown, China A-Share Investing hedge funds have posted annualised returns of 5.38%, while the Shanghai A Share Index is in the red with annualised losses of 0.37%. Annualised standard deviation over this period for China A-Share Investing hedge fund managers came in at 14.47% versus 24.60% for the Shanghai A-Share Index.

Figure 1: China A-Share Investing hedge funds since 2009

Table 1 summarises the key performance statistics for China A-Shares Investing hedge funds relative to underlying markets and the broader Eurekahedge Greater China Equity Long/Short Hedge Fund Index. Key takeaways include:

1. China A-Shares Investing hedge funds have outperformed the Shanghai A Share Index for all of the annual years depicted below barring 2014, whilst performance relative to the Shenzhen Composite Index has been mixed.
2. As at close of 1H 2017, China A-Shares Investing hedge funds have outperformed all underlying markets with the exception of the CSI 300 Index which they trail marginally by 0.44%. The Eurekahedge China A-Shares Investing Hedge Fund Index is up 10.33% for the year.
3. Over all the five, three and two year annualised period, China A-Shares Investing hedge funds have posted lower annualised volatility compared to the underlying market benchmarks depicted in Table 1.
4. Sharpe ratios (risk-adjusted returns) for China A-Shares Investing hedge funds have exceeded underlying markets over the five year period. Over a three year time horizon, the statement holds true with the exception for the CSI 300 Index which posted a Sharpe ratio of 0.61 versus 0.55 for the China A-Shares Investing hedge funds.
5. Over the past two years, which factors in the Chinese equity market crash of 2015, annualised returns for China A-Shares Investing hedge funds are in the red with losses of 5.69%, while losses for underlying markets have ranged in excess of double digits (CSI Index being the exception with losses of 9.46% on a two-year annualised basis).

Source: Eurekahedge

Table 2 shows the correlation matrix of China A-Shares Investing hedge funds with respect to underlying markets and the broader Eurekahedge Greater China Long/Short Equities Hedge Fund Index. As can be expected, correlation is high with respect to underlying markets and points towards the directional exposure to underlying equity markets for A-Shares Investing hedge funds. This should not come as a surprise given the constraints, both regulatory and cost related, that managers have to contend with when shorting underlying stocks. Generally, China A-Shares Investing hedge funds tend to operate with a long-bias to underlying equity markets though managers will tend to cut back on their long bias during periods of market stress which helps them preserve gains and outperform underlying markets.

Table 2: Correlation matrix

Figure 2 shows that China A-Share investing hedge funds have largely delivered positive alpha over the 79 month period depicted in the chart with alpha of 0.41%. The 12 month rolling beta to the underlying Shanghai A Shares Index has in recent times trended lower, especially from the levels seen in end-2015. One reason for this could be concentrated exposure to selective stocks and sectors in the A-Shares market as well a reduction in exposure to the underling Shanghai A Shares market which has lagged behind the larger and more liquid CSI 300 Index constituents. It would be interesting to see how directional exposure to A-shares, which rises during strong bull-market runs in Chinese equities plays out for the remainder of the year especially given MSCI mandate to include Chinese A-shares to its Emerging Markets Indices.

Figure 2: China A-Share Investing hedge alpha/beta vs. Shanghai A Shares Index

The full article inclusive of all charts and tables is available in The Eurekahedge Report accessible to paying subscribers only.

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