A top-performing Chinese macro hedge fund is sounding the alarm over a popular type of derivative following the country’s stock rally.
(Bloomberg) — A top-performing Chinese macro hedge fund is sounding the alarm over a popular type of derivative following the country’s stock rally.
Influential fund manager Li Bei advised against investing in so-called “snowball” products, a tool she used to buy at the bottom of the market late last year. Given the rebound in China equities, investors buying the option-based contracts could suffer losses, the founder of Shanghai Banxia Investment Management Center said in an article on March 12.
Li made the comments after seeing financial institutions use her trade to promote the products. Her warnings are a fresh reminder of the dangers of the bet that burnt even the largest financial institutions in Europe.
“Times have changed and snowball-type products have become less of an optimal choice,” Li wrote, adding she doesn’t want to see people suffer losses by following her moves.
Li holds an audience. Banxia’s annualized 33% return for the past five years makes it the best performer among multi-asset funds running at least 10 billion yuan ($1.5 billion). It ranks No. 2 for all hedge fund strategies, according to Shenzhen PaiPaiWang Investment & Management Co.
Li used snowball derivatives in September and later last year to add net-long exposure to domestic stocks, positioning for what she judged was the cusp of a bull market. The company chose to not buy stocks directly, as a further 10% decline was still possible, according to its September investor letter dated Oct. 10.
The benchmark CSI 300 Index fell a further 6% through the end of October, and has since rallied 14%.
The potential risks of buying these products now are “obviously significantly higher,” Li said.
Snowballs are similar to so-called autocallables and equity-linked securities in other markets. They can generate annualized returns typically between 12% to 20% in China, as long as the underlying indexes or individual stocks don’t fall below a preset level.
Li hasn’t built any positions with “snowball” products this year, and will “absolutely not buy” any in the next month, she wrote.
The CSI 500 Smallcap Index, to which many “snowballs” are linked, has rallied. On top of that, many mainstream products have adjusted the trigger for losses to a 20% decline from 25%, Li wrote. The average return on a typical two-year product has also dropped to less than 10% from almost 20%, she said.
Li declined to comment further on her article.
China is expected to remain restrained with stimulus policies, suggesting that credit growth will slow after March, according to a Banxia February investor letter seen by Bloomberg.
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