The Trillion-Dollar Quant Fund Enigma: A Game With Restrictions

By Lili Yu

Edited by Jing Liu

The Wild Ride of 2021

Without warning, Huaxin Securities Shanghai Branch vanished from the Dragon Tiger List.

The Dragon Tiger List is a daily ranking of stocks with the largest price swings and highest turnover rates on China's two main exchanges, showing the top five brokerages by buy and sell amounts for each. Huaxin Securities Shanghai Branch (hereafter: Huaxin Shanghai) was a regular fixture: throughout 2021, it ranked second among all brokerages with 3,702 appearances and total turnover of 91.884 billion yuan. In early March, it briefly claimed the top spot. The day before its disappearance — March 14, 2022 — it still had five stocks on the list simultaneously.

Because it served numerous quantitative private funds, Huaxin Shanghai's trading seat had earned the nickname "quant headquarters." The more frequent its appearances, the more they validated the efficiency and agility of board-rushing strategies. For Huaxin Securities itself, which provided trading channels for these strategies, it was also proof of superior technological performance.

But since March 15, Huaxin Shanghai has never reappeared on the Dragon Tiger List.

The reasons remain disputed. Despite repeated official denials, rumors persist: from "under regulatory investigation" to "executives arrested" to "suspected money laundering." But multiple quantitative industry insiders who spoke with An Yong Waves believe the episode likely connects to one backdrop: over the past several months of secondary market decline, some have blamed quant funds' herding behavior for driving market sentiment lower.

Before the collective silence, quant funds had just experienced their most frenzied year in China.

In August 2021, in Shanghai's Lujiazui, the summer heat refused to break. Amid clusters of skyscrapers, Zhang Chenying, then partner and investment director at Egret Asset Management — about to join the 10-billion-yuan club — told An Yong Waves with a sigh: "People used to think quant wasn't a way to make money every week, or make big money. The second quarter shattered that assumption."

The next six months climbed higher still. By year-end 2021, 24 quant shops managing over 10 billion yuan averaged returns of 18.32%, while 57 (performance-disclosing) fundamental shops over the same threshold managed only 6.59%. Of the top ten performers among 82 tracked 10-billion-yuan private funds, quant funds claimed six seats.

A founder of a newly minted 10-billion-yuan quant shop told An Yong Waves: "Before 2019, breaking 10 billion was not a small goal for quant private funds — it was an ambitious one." That year, 25 Chinese quant funds achieved this "ambitious goal." Two years prior, that number was six.

Simply put, unlike fundamental investing, which emphasizes company research and financial analysis, quant is pure mathematical logic; data is the only metric: "show me your data, not opinion." And it's not limited to equities — quant sees heavy use in futures and options markets too.

Having historical data foundations and proprietary strategy logic is what separates mainstream quant from many other quant-style investments. Take Huaxin Shanghai from the opening: industry insiders told An Yong Waves that the real traders there were typically quant-oriented hot money, not mainstream quant private funds.

For the longest time, quant was an isolated industry. But over the past two years, wealth stories about it pushed it into the mainstream. There was the sensational "50 million yuan year-end bonus" incident. At a 2019 industry summit, a quant veteran even rallied young people with this line: "You didn't choose the wrong industry. Overseas hedge fund managers can earn more than Taylor Swift (the American singer who once topped Forbes' highest-paid entertainers list with $170 million annually). In the future, your income can surpass Faye Wong too."

Aggressive expansion quickly bred suspicion. On September 22, 2021, when A-share trading volume broke one trillion yuan again — after 43 consecutive trading days (July 21 to September 17) of trillion-yuan sessions — an ominous feeling gripped the market: before the 2015 crash, there had been a similar 43-day streak of trillion-yuan euphoria. The massive trading volume became a puzzle: where exactly was the extra 400 billion yuan in average daily turnover coming from?

Quant trading, often associated with high turnover and high frequency, was immediately thrust into the crosshairs. Quant funds then began seeing sharp drawdowns.

On December 28, High-Flyer Quant, once a 100-billion-yuan giant, issued An Explanation on High-Flyer's Recent Performance, expressing "deep regret" that its products had hit historical maximum drawdowns. Three months later, it revealed it had voluntarily shrunk to around 50 billion yuan — before which it had even advised ordinary investors who couldn't stomach volatility to redeem.

Data from Simuwang shows that through the first two months of 2022, 90% of China's 10-billion-yuan quant shops were facing losses to varying degrees.

Pessimism peaked again recently. On March 18, Xiao Gang, CPPCC National Committee member and former CSRC chairman, told media about several problems with quant investing: "model-driven consensus expectations," "amplified market volatility," and "unfairness to retail investors." He concluded: "For China's market, quant should be restricted."

From a marginal investment approach to household name, quant investing took 11 years in China. But in just six months, this once-mythologized investment form walked into the fog.

Born Isolated

On a gray, overcast afternoon in February 1961, MIT mathematics professor Ed Thorp received an unexpected visitor.

The man was around 65, a wealthy businessman from New Jersey. His purpose: invite Thorp to Nevada casinos to test the blackjack card-counting strategy Thorp had recently presented at an American Mathematical Association conference. He would provide the gambling capital.

In a space without clocks or windows, amid dense crowds of drinkers, smokers, and cocktail glasses, the mathematics professor won so much at the tables that dealers and casino managers' scalps went numb — ultimately forcing the hotel association to change the rules.

The secret lay in Thorp's grasp of the core problem in gambling or investing: probability and frequency. In any game, when high probability combines with high frequency, you have a money machine. The key is rapidly calculating the optimal strategy's win probability for each hand — bet more when favorable, less when not.

In a sense, this was an early form of quant investing. Eight years later, Thorp established the first fund in financial history to rely on mathematical models and quantitative algorithmic strategies.

Yet as a financial tool, the quant industry has long been ruled by non-financial people: they come more from mathematics, computer science, statistics, physics, even astronomy. Unlike Wall Street's peacocking, quant funds have perennially cultivated low profiles: even something as storied as Jim Simons' Renaissance Technologies' Medallion Fund maintains a website of just a few lines, seemingly unupdated since around 2000. Simons himself has long lived in seclusion on quiet Long Island.

One media investigation of Jump Trading, one of the world's most secretive top-tier high-frequency quant giants, found its headquarters not on Wall Street where financial institutions cluster, but in Chicago's north side. Its early offices were even in public housing — a dilapidated warehouse with upper floors being progressively demolished.

"Unwilling to express themselves, heavily tech-nerd culture." In Xie Xiaoyang's view, founder of Tevian Capital, this is also a rather isolated industry in China. One FOF fund manager at a brokerage who invests in quant even considers "bookishness" a standard for doing quant well, joking that one renowned quant shop literally wrote "nerd" into its corporate culture creed. A marketing director at a quant private fund, describing the founder's personality to An Yong Waves, used these metaphors: "speaks to you from three meters away," "after a late-night work call, hangs up before you can even exchange pleasantries."

This is indeed an industry where you can almost work with the door closed. In the US, with more diverse leveraged funding channels, some quant institutions can run proprietary strategies indefinitely, staying closed off completely. In fact, Renaissance's stunningly profitable Medallion Fund is also a prop fund open only to employees, former employees, and a handful of legacy clients — outside investors cannot freely purchase it.

On April 6, 2010, the official launch of China's first stock index futures contract — the CSI 300 Index Futures — meant quant funds finally had viable hedging tools, making it known as the birth year of Chinese quant investing. That same year, Yuan Yu founded Ming Shi Investment; in 2011, Ren Sihong founded Jin De Asset; in 2012, Wang Chen founded Ubiquant Investment. In subsequent years, Lingjun Investment, Ruitian Investment, Minghong Investment, and High-Flyer Quant were established. Among them, Minghong and High-Flyer once reached the 100-billion-yuan scale.

But even so, due to extremely high barriers to understanding, most people still don't comprehend what quant actually is. "Many people call quant investing a 'black box,'" Zhang Chenying, partner and investment director at Egret Asset Management, told us. She immediately added: "Especially after machine learning and deep learning were applied, often you need to abandon interpretability and do more rigorous algorithms and stress testing, observing and understanding the market through mathematical metrics."

Thus the market is filled with legends about quant investing. Many see retail investors as quant's counterparties, even believing that "quant strategies target small- and mid-cap stocks, moving in and out rapidly, causing prices to fluctuate wildly and inducing impulsive trading by small retail investors who get harvested."

Within quant investing, there's fundamental quant combining fundamental investing with quant methods, and more purist approaches — price-volume strategy quant based on data mining and analysis. And on who quant investing's counterparties are, even they have substantial disagreements.

Xu Zhongxiang, founder of Rayliant Global Advisors (Shanghai), a foreign private fund focused on fundamental quant, believes that "price-volume strategies favor small-caps because that's where most retail investors gather. Retail trading volume is large; price-volume strategies taking the other side of their trades makes good money, which is why the past two years have been very profitable."

Meanwhile, an investment director at a mid-sized quant fund stated: "Short-cycle quant trading strategies aren't limited to small- and mid-cap stocks either, otherwise market cap drift creates style exposure that prevents strategies from rising stably long-term." In his view, irrational volatility first comes from emotional trading; when irrationality appears, whether rational fundamental traders or quant traders, both exploit such opportunities to profit while bringing prices back to rationality. In fact, most quant private funds' risk controls also limit individual stock trading volume proportions to avoid market impact from their own trading and higher transaction costs.

Xie Xiaoyang of Tevian Capital told An Yong Waves: "No mainstream quant shop's strategy would identify retail investor orders and specifically trade against them. If there's a so-called opponent, it would definitely be someone with the same angle as us."

And a perfect "prey" for quant investing, in one quant fund principal's view, would be: someone whose behavior patterns at position opening and closing remain consistent long-term. "Because then, your behavior becomes predictable."

Controversy and Defense

Among the many debates about quant, "high-frequency strategies" are its most controversial topic.

Speed is indeed the signature skill of many quant giants. Futures high-frequency giant Jump Trading's obsession with speed borders on legendary. The story goes that while other companies were still leasing microwave towers, it had already spent heavily to acquire a decommissioned 800-foot microwave tower — once used by NATO forces in the Balkans in 1983 to transmit intelligence. Compared to fiber optics, microwave tower technology can cut transmission time by half.

"With microwave lines from Chicago to the West Coast, Tokyo to Maruyama, Jump Trading can see copper or gold prices in Chicago milliseconds faster than domestic teams," a small high-frequency quant fund principal told An Yong Waves — and milliseconds mean enough to wipe the floor with domestic teams.

In fact, since Jump Trading entered China in 2019, it has used speed to defeat numerous domestic players, even forcing some quant funds to migrate from commodity futures to the larger-capacity stock market.

"Especially in commodity futures, this competition is crushing," the above fund principal told us. Because overseas markets have pricing dominance in energy, non-ferrous metals, agricultural products and other commodities, domestic quant companies doing commodity futures need to reference overseas futures exchange prices. This makes whoever masters speed the top of the food chain.

China's domestic commodity futures market is no exception. As early as 2010, media reported stories of many futures companies moving offices into the Shanghai Futures Exchange building itself — for one purpose only: proximity to the exchange's server room.

A mid-sized quant fund investment director told An Yong Waves that although domestic high-frequency futures competition hasn't reached microwave levels yet, the era of competing over whose fiber optic cable is "straighter" has arrived. For example, for the distance from Chongming Island to the Shanghai Futures Exchange, because domestic cables use existing server rooms, there are typically multiple telecom providers' facilities between any two points, stringing together inevitably into a curve. "But some crazy people would think of buying or leasing lines along the route, then 'straightening' them out."

In widely circulated definitions, high-frequency trading is fast (also called low-latency) and trades frequently (also called high-turnover), but there are no fixed quantitative standards. Industry insiders told An Yong Waves that currently in China's quant high-frequency domain, the securities market is at the millisecond level, futures at the microsecond level, and overseas at the nanosecond level.

But speed often means frenzy — this is the core belief of high-frequency opponents. In their view, new technology undermines market fairness, harming some investors' interests. "When control is inadequate, it triggers chain reactions, amplifying market volatility," wrote Michael Lewis, author of The Big Short and Liar's Poker, in his widely circulated Flash Boys: A Wall Street Revolt, taking a critical stance toward high-frequency trading and viewing HFT technology as an accomplice to Wall Street's fleecing of investors.

But in the Chinese edition's preface, economist Ba Shusong offered a caveat: the real market situation may not be so dire. Because behind high-tech application lies a tangle of interests: many traditional powers accuse new technologies of creating unfair competition, yet this competition can actually reduce transaction costs and bid-ask spreads, improving liquidity.

As for whether current market quant strategies are mostly medium- to high-frequency, the industry is also divided. One fundamental quant research analyst believes that "fundamental quant is still rare domestically; for stocks, many are high-frequency quant with 100x+ turnover, even higher," while a brokerage analyst told An Yong Waves: "For quant equity strategies with AUM over 10 billion, average annualized daily holding turnover is only 20-50x."

A head quant private fund principal added to An Yong Waves: "For domestic high-frequency, stocks and futures are completely different orders of magnitude, and the US stock market and Chinese stock market are likewise not comparable." According to him, although domestically stocks can also do intraday round-trip trading through securities lending and building base positions, stocks are T+1 while futures are T+0 — completely different leagues.

Compared to US quant's "cable wars," he noted "this differs greatly from China's national conditions." "For example, one US stock can trade on 13 exchanges. If quotes differ, whoever gets prices or executes faster decides everything. In China, except for some cross-market stocks, most stocks can only trade on one exchange at a time."

Some have tried to answer this from a technical perspective. A founder of a 10-billion-yuan-scale quant fund told An Yong Waves: "Currently there's no very pure, narrowly defined high-frequency trading in China's stock market, which relates to the speed of trading signals, market data rules, and systems here." China doesn't allow privately built communication lines; so-called dedicated lines are merely "reserved bandwidth" within the three major carriers' systems. Thus everyone can only "make choices within a controlled framework."

Another key obstacle is scale. Though "scale is the number one killer of returns" is near-consensus in finance, it manifests especially acutely in quant funds. "The larger the scale, achieving high turnover in short time necessarily sacrifices price advantage," "the higher the market impact cost, the smaller the return space left," a quant private fund principal told An Yong Waves. In his view, such high-frequency strategies are mostly applied to proprietary capital; as asset management scale expands, it shifts more toward multi-cycle, multi-signal hybrid strategies.

Chinese quant funds' expansion path largely confirms this. In the memory of a principal at an early-established mid-sized quant shop, high-frequency strategies once dominated in 2017-2018, but by around 2019, among scaled quant private funds, high-frequency players were already losing to "full-frequency + multi-strategy players."

"The longest-standing fundamental misreading about quant funds is equating high-frequency with quant," a technical director at a mid-sized quant fund told An Yong Waves. Xie Xiaoyang of Tevian Capital offered a vivid analogy: "(Equating high-frequency with quant) is like equating Ferrari with the auto industry."

Of course, there are indeed many irregularities in China's high-frequency domain. Such as fake orders, covert use of prohibited technology, even flash crashes. A High-Frequency Trading Research Report published by the Beijing Financial Analysts Association showed that "historically there are indeed examples of market volatility triggered by high-frequency trading, but this doesn't mean crises caused by high-frequency trading occur frequently or are inevitable."

The Fate of a New Species

2022 was not the first time quant funds encountered desolation.

In early years, quant indeed had an era of easy wins. A founder of an early-established 10-billion-yuan private fund told An Yong Waves that in the early A-share market obsessed with "speculating small, speculating new, speculating bad, speculating short," the market was so inefficient that: find a specific phenomenon, write two hundred lines of code, open it and start making money.

But by June 2015, as the Shanghai Composite surged to 5178 points, anxious regulators began cracking down on off-exchange margin financing. In the subsequent crackdown, quant institutions holding large CSI 300 index futures short positions for neutral strategy hedging needs were classified by regulators as sources of volatility.

Afterward, exchanges began restricting trading accounts of 34 "foreign forces" including globally renowned quant hedge fund Citadel. This is also why overseas quant giants have been cautious about re-entering China.

Subsequently, regulators gradually tightened index futures trading: raising margin requirements, limiting intraday opening positions from unlimited to just 10 contracts, and raising closing fees more than 100x above pre-crash levels.

Trading restrictions caused quant strategy costs to spike. Combined with the post-crash stock market's return to large-cap trends, this was doubly disastrous for quant investing. Many quant private funds were wiped out.

From 2017 to 2019, as regulatory focus shifted to the more pressing issue of financial deleveraging, index futures began gradual loosening. The availability of operating conditions allowed quant private funds to develop more equity strategies. According to Simuwang data, as of end-October 2021, equity strategies accounted for about 60% of 10-billion-yuan private funds.

"The explosion of quant fund equity strategies in recent years also benefited from the reopening of broker stock trading interfaces that had been suspended," a 10-billion-yuan private fund founder told An Yong Waves. After the 2015 market anomaly, regulators required all programmatic trading interfaces to be suspended, forcing many quant private funds to operate manually.

In recent years, some brokers have worked around this system through reverse procurement, enabling more quant strategies.

Accompanied by scale surges, trading strategy crowding, and regulatory impacts, quant's predicament followed.

In the second half of last year, a marketing director at a quant institution that had just joined the 10-billion-yuan club told An Yong Waves that she and her mini-team, carrying green health code stars, at a rhythm of three nucleic acid tests in seven days, set a record of "completing 200 online and offline roadshows in 40 days." The sudden good market conditions led many institutions to absorb capital beyond capacity; as scale expanded rapidly, returns also quickly dropped. Soon, this institution experienced unprecedented drawdowns.

At end-November, in a private courtyard-style teahouse by Beijing's Houhai, a partner at a top quant shop told An Yong: "The days ahead won't be easy; a wave will definitely die off, because scale rose too fast."

Events proved him right. Months later, many quant institutions saw significant shrinkage, especially those near the 100-billion-yuan threshold; some contracted by as much as 50%.

Surging scale also brought strategy decay. A head quant institution principal told us that "in an increasingly open market, as many strategies and data are rapidly utilized, the higher returns of the dividend period will quickly decline and normalize to regular return levels," therefore "whenever quant-managed assets expand by 2-3x, models, strategies, and execution all need upgrading and optimization. If asset management scale exceeds the firm's original strategy capacity without timely updates, the strategy itself will decay."

As for whether quant herding behavior amplifies market volatility, macro research fund manager Yuan Yuwei noted in a March 20 public account post that this is not unique to quant: "Whether manual trading or quant investing, once trends form, herding occurs," "like manual trading's Moutai Index, Ningde Index, A-share liquor funds, new energy funds — they're also 'homogenized trading.'"

Thus, when market voices attributed the overall market slump to "quant herding behavior amplifying market volatility," a founder at a head quant private fund told An Yong Waves in an interview: "In the earlier crash, head quant institutions didn't significantly reduce positions, and some even had net buying, with information coordination with regulators. Many people think quant herding amplifies market volatility, but it's actually not so."

"Rapid rise, rapid scale expansion, then rapid decline and disappearance — this seems like quant industry's death loop, like a Sword of Damocles hanging over our heads." High-Flyer Quant CEO Lu Zhengzhe told media in an interview as early as 2020 — and his words still apply today.

The brutal competition has made quant investing's arms race for talent and hardware spectacular.

Zhang Chenying, partner and investment director at Egret Asset Management, told An Yong Waves: "In today's Chinese quant private funds, having numerous IMO (Mathematics Olympiad), IPhO (Physics Olympiad), IChO (Chemistry Olympiad), and IOI (Informatics Olympiad) medalists is already an industry 'standard.'"

The vertical quant industry public account "Quantitative Investment and Machine Learning" told An Yong Waves that many quant private funds have therefore pushed company benefits to the extreme. Such as unlimited meal subsidies for food delivery, dedicated former Starbucks baristas, unlimited vacation (as long as work is done)...

Hardware competition is also spectacle-worthy. As China's first quant private fund with a supercomputer, Hangzhou-based High-Flyer officially launched its AI supercomputer "Firefly No. 1" in 2020, then began deploying "Firefly No. 2" in 2021. A more intuitive comparison between the two: the former cost over 100 million yuan, the latter in the billion-yuan range; the former occupied about one basketball court, the latter about ten; if Firefly No. 1 could perform 184 quadrillion floating-point operations per second, equivalent to 40,000 personal computers, then Firefly No. 2 equals 760,000 personal computers.

Though after multiple rounds of rapid reshuffling, quant private fund strategies have long begun diverging: some still do narrow price-volume quant, others have long mixed in fundamentals, even cutting into alternative data; some still fight in single markets, others have long diversified across markets — though comparatively, the domestic market still has many restrictions: such as financial markets' short history, meaning scarce financial instruments, derivatives, and effective data volumes.

Current quant investing remains in an early land-grab stage — as one head quant fund principal told An Yong Waves in an interview: "Quant investing in China is, after all, still a new species."

This means there is no确定的霸主一统江湖. Whoever fails to iterate and update fast enough will be rapidly replaced. From this perspective, the setbacks and even controversies quant funds currently face are, in some sense, to be expected.

Xie Xiaoyang of Tevian Capital believes that people suited to this industry must have "intellectual curiosity": facing the "black box," they need to constantly jump out of old experience and "systematically, with mathematical principle support, guess," and "mathematical language is a language with very little ambiguity; things researched with mathematics are a small step toward objective truth."

Ubiquant founder Wang Chen also believes: "In this industry, you must think a little more than others to make money."

After the 2022 Spring Festival, a head quant private fund founder coldly posted on his social media a photo of a takeout box full of leftovers, with the note: "Current status of quant fund managers." At the time, most people's imagination of the quant circle still lingered on the legend of the "50 million year-end bonus."

After March, following voluntary fund closures and model iteration, many quant private fund products' excess returns began gradually returning. But the above fund founder told An Yong Waves that the noise has stopped; "calm and tedium are this circle's normal state."

Image source | IC Photo

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