What are the risks of stock market hedge funds?

Investment risks cannot be completely avoided. What investors have to do is to recognize the risks and better reduce them. So, what are the risks of stock market hedge funds?

What are the risks of hedge funds? Are the risks high? Hedge funds, an early form of fund management based on conservative lending strategies of hedging and value preservation, mainly use hedging to avoid risks and preserve assets. As time goes by, hedge funds have become a new lending model, pursuing high expected annual returns and taking high risks through short selling and other operational methods. Recently, the stock market has remained uncertain, and lenders have gradually turned their attention to various types of hedge funds. We often see hedge funds advertising stable and expected annual returns. So, what is the risk level of hedge funds, and what are the risks?

1. Large and small cap style risks

Before the CICC launched SSE 50 and CSI 500 stock index futures this year , there is only one target for hedge funds to hedge in the stock index futures market - CSI 300 stock index futures. The CSI 300 represents large-cap stocks among A-shares. If a market-neutral strategy is adopted to hedge the CSI 300 stock index futures, it is very likely that the selected stock portfolio will be smaller-cap than the CSI 300. This difference in large-cap and large-cap styles also hides certain risks. For example, the market-neutral "black swan" event in December 2014 was due to the overperformance of large-cap stocks, especially financial stocks represented by banks and non-bank finance. caused by the rise. In the market neutral strategy, if the bulls cannot outrun the shorts, a retracement will occur.

2. Scale risk

With the popularity of lenders, hedge funds have undergone significant changes in both issuance speed and financing scale, and the management scale of some private equity funds has also It has doubled in the past six months. Different from the traditional fund size, which is limited by the amount of funds that can be accommodated by the strategy itself. Specifically, the amount of funds that can be accommodated is closely related to factors such as the trading frequency of the strategy, the daily trading volume of the target, and the fund size of similar strategies on the market. relationship.

When the fund size increases rapidly and exceeds the upper limit of funds that the strategy can accommodate, fund companies often need to add new strategies to absorb excess funds. When no new strategies are added, the impact cost of the original strategy will increase, resulting in a reduction in the expected annual return rate of the strategy. To put it simply, for example, when the holdings of a certain stock in the portfolio exceed a certain upper limit, it will have a certain impact on the market price during the exit process, causing the stock price to fall while selling, thus reducing the expected annual return. . Generally speaking, the amount of funds that statistical arbitrage strategies can accommodate is less than that of traditional multi-factor strategies, while the amount of funds that can be accommodated by intraday trend strategies such as stock index futures is even smaller.

For my country’s financial market, stock index futures are still new. Compared with the securities market, which has a history of more than 20 years, the oldest stock index futures only have a history of more than 5 years. For such financial derivatives with natural leverage, supervision will also be more stringent. Since the stock market adjustment on June 15, the China Financial Futures Exchange has also made many adjustments to the trading rules of stock index futures, which has also affected the daily operations of most hedge funds. At the most stringent level, all types of futures accounts are not allowed to open short orders. In this case, hedge funds can only close their spot positions and operate with low or even short positions. This kind of regulatory restriction is not only reflected on the futures side, but also on the spot side. On July 30, the Shanghai Stock Exchange and the Shenzhen Stock Exchange imposed restrictions on 24 stock trading accounts, many of which were accounts of quantitative hedge funds. The reason was that the frequency of application and withdrawal of orders was too high, which affected the market price trend.

Risks arising from regulatory restrictions are uncontrollable risks. In the long run, as the domestic financial market further matures, we have reason to believe that such regulations will gradually fade out of people’s sight. Hedge funds policy risks will gradually weaken. But in the short term, if the stock market continues to fluctuate, restrictions on stock index futures will continue, and the operation of hedge funds will still be affected to a certain extent.

4. Basis risk

For domestic hedge funds, there are not many ways to hedge. Most hedge funds use stock index futures to hedge. Among them, basis risk The poor factors are critical. When the basis is positive, arbitrage can be achieved by selling stock index futures and buying spot or ETF at the same time. Therefore, when a large positive basis appears, it will often disappear quickly and return to normal. However, due to the high cost of stock lending, when a negative basis occurs, it is often not possible to buy stock indexes and sell spot stocks for reverse arbitrage, which results in a negative basis that may last for a long time.

When there is a large discount on the futures side, hedge funds shorting stock index futures will face the risk of basis convergence on the delivery day. If the monthly strategy expects the annual return to be lower than the loss caused by the basis discount, The overall portfolio will have a negative expected annual return. At present, the market is undergoing shock and adjustment, and lenders are more cautious, which is reflected in the large discount on stock index futures. We compared the basis spreads of the four contracts of the CSI 500 stock index futures in the past month and found that except for the normal convergence of the basis spread of the main contract (IC1508) on the delivery day, the four contracts all had negative basis spreads and discounts at other times. The lowest one, IC1508, had an average discount of -3.67 that month. Such a deep discount would be difficult for most market neutral hedge funds to operate. We have also observed that since July, the net value curves of public and private hedge funds in the market have been relatively flat, and the overall positions of funds have also been relatively light.