China’s launch of small-cap derivatives spawns new strategies and funds

A man walks past an electronic screen showing the Shanghai Stock Index, in Shanghai, China, 24 September 2021.

Futures and options based on China’s small-cap CSI 1000 index began trading in Shanghai on Friday, spawning new products and strategies from fund managers looking to capitalize on new hedging instruments. The derivatives, which debuted on the China Financial Futures Exchange (CFFEX), offer investors tools to manage risk in a basket of 1,000 mostly innovative small tech companies, sparking interest in the sector. Four exchange-traded funds (ETFs) tracking the CSI 1000 also launched on Friday, seeking to raise 8 billion yuan ($1.18 billion) each. In the area of ​​hedge funds, two products that track the index and seek enhanced returns were created this month, according to the fund association. “The new derivatives are likely to boost investor confidence in owning small caps,” said Chen Hongting, head of options investing at the Trading Art Association. Previously, investors were reluctant to buy small, volatile stocks without effective hedging tools, Chen added. Other strategies based on CSI 1000 index futures and options are expected to emerge, potentially increasing the size and liquidity of CSI 1000 index ETFs, according to Guosheng Securities. China’s securities regulator said on Monday that the launch of futures and options on the CSI 1000 index is a key step towards deepening capital market reforms and can help further satisfy investors’ need for hedge against risk. This is a particularly welcome development for the rapidly growing hedge fund industry in China, which builds various quantitative strategies using derivatives. Global hedge fund firms including Bridgewater, Winton, Man Group and Two Sigma have all entered the Chinese market. The four ETFs launched on Friday are managed by E Fund Management Co, China Universal Asset Management Co, Fullgoal Fund Management Co and GF Fund Management Co. “ETFs can bring more money to these growing businesses and offer retail investors a channel to buy small cap stocks,” said Ade Chen, managing director of Fund Investment. He also told Reuters that his company would find arbitrage opportunities using CSI 1000 index futures because higher volatility in small caps would potentially generate higher returns for his strategy. Previously, CFFEX only had three types of equity index futures products, following the SSE50 mega-cap index, the CSI300 blue chip index and the CSI500 small cap index respectively. Fund managers can also design structured products based on the new derivatives, or use them as hedging tools in the so-called market-neutral strategy, said Zhang Chao, an analyst during a roadshow of GF Fund Management.

($1 = 6.7665 Chinese yuan renminbi)

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