China Stocks Face Big Risk as Thousands of Hedge Funds Near Point Where They Have to Dump Shares

(Bloomberg) — China’s almost-trillion dollar hedge fund industry risks worsening the turmoil in its stock market as deepening portfolio losses trigger forced selling by some managers.

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About 2,350 stock-related hedge funds last month dropped below a threshold that typically activates clauses requiring them to slash exposures, with many headed toward a level that mandates liquidation, according to an industry data provider. Such signs of stress were “close to the historical high,” China Merchants Securities Co. analysts said in a report this month.

Unusual elsewhere, the selling rules are common in China, where they were introduced to protect hedge fund investors from outsized losses. They can, however, backfire in a falling market when many funds are forced to pare their stock holdings. In a sign regulators are taking notice, stock exchanges have been asking some funds to assess the pressure on their portfolios ​since March, according to people with knowledge of the matter, who asked not to be named as the discussions are private.

“The pressure on the market can be fairly big following the industry’s rapid expansion last year, especially if the quant funds’ reductions are concentrated,” given similarities in their trading strategies, said Yan Hong, director of the China Hedge Fund Research Center at the Shanghai Advanced Institute of Finance. While not normally a problem, these measures are “forcing many hedge funds to sell” in this year’s “highly volatile market,” he said.

Despite brief periods of respite, China’s benchmark CSI 300 Index had its worst January to April period since 2008. It has fallen about 19% so far this year, as a stringent Covid Zero policy and crackdowns on private enterprise combined to sap investor confidence. A slew of disappointing economic data from China this month also highlighted the growing toll of a lockdown-dependent approach, raising concerns that markets will remain under pressure unless China shifts its approach.

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For a hedge fund industry that surged 66%…


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