Quantitative strategies are set to be the next significant wave of trading to hit the China market via Stock Connect, according to market players.
The strategies, which use complex computer strategies to make trades, have been seen as likely beneficiaries of the cross-border scheme, partly because of the expanded universe of stocks they will be able to access
And with Shenzhen-Hong Kong Stock Connect set to launch in the coming months, the trading link extension could be a trigger for even more quant strategies to move into China stocks.
So far, much of the Shanghai-Hong Kong trading link’s northbound volumes have been driven by individual investors, private bank clients and hedge funds. Institutional long-only clients continue to avoid the link due to beneficial ownership issues, as MSCI’s decision this week to not include A-shares has highlighted.
But with the upcoming Shenzhen-Hong Kong Stock Connect expected to launch by the second half of this year, quant strategies, which use complex computer models to make trading decisions, could have an extra incentive to come online.
“I think one client group who will trade is the quantitative side, as they would be able to access a broader universe of securities,” said David Rabinowitz, head of direct execution services for Asia at UBS, adding that such strategies often spend significant time analysing market data, and adding Shenzhen to the scheme would help to more fully optimise their models.
Other strategies that would be appropriate for China trading include factor models, which involve constructing portfolios according to categories such as macroeconomic, fundamental and statistical data.
Adding Shenzhen into the mix would give the strategies a larger universe of stocks when building trading models for investment analysis, such as valuations of different companies, sectors and the wider economic data.
Khôi Le Binh, Asia head of quantitative strategy at Deutsche Bank, noted that quantitative strategists (and traditional fund managers) would benefit from access to the Shenzhen market. Some stocks from the city’s high-growth ChiNext board are likely to be included in the trading link extension.
With 2,500 stocks listed in Shanghai and Shenzhen, a fundamental analyst would not be expected to know all of the names. This would mean quantitative managers could use their computer models to their advantage. They would add value not necessarily by knowing all the details of a particular set of companies, but by processing large information sets across all China A shares to rank them.
Meanwhile a fundamental manager might be interested in leveraging quantitative managers’ data exploration methods, if not their share recommendations, to narrow down the universe of stocks they will research.
“In our research on China A shares, we have been able to identify valuation drivers that are useful to understand how mainland listed stocks are priced by market participants. These valuation drivers include profitability metrics, proxies for the cost of capital and growth rate,” said Le Binh.
“Armed with the results of our analysis, we can derive expected fair values that can be used by managers willing to use relative valuation measures to screen stocks.”
“Our framework allows us to take into account the impact of macro-economic forces such as a relaxation in monetary policy or other policy shocks that can alter our cost of capital proxies, and hence the fair value expected by market participants.”
AsianInvestor is hosting a conference to discuss the opportunities created by Stock Connect on June 29 in Hong Kong. For further details click here