Apology from Shanghai Power Asset Management

By Samuel Shen and Tom Westbrook

SHANGHAI/SINGAPORE (Reuters) – Shanghai Power Asset Management Co has apologized to investors and ceased its arbitrage strategy after significant losses, becoming the latest Chinese hedge fund impacted by the volatile market following governmental efforts to stimulate the economy and achieve growth targets.

Power Asset, which trades options to hedge against market volatility, reported over $10 million in losses in just the past month, marking its largest loss ever as a result of a stock market rally triggered by China's stimulus package announced on September 24.

> "Due to the major changes in market environment, our options strategy was maimed," Power Asset stated in a release, detailing a phase-out of the strategy managing approximately 400 million yuan ($56 million).

The flagship fund under this strategy lost a fifth of its value, as many funds suffered due to the swift market changes.

> "We feel deeply guilty, and sorry, for the loss suffered by our investors," Power Asset expressed.

Stock turnover and volatility reached record highs following Beijing's stimulus announcement. Investors noticed that options that allowed for purchasing stocks rapidly increased in cost, according to Rajesh Manwani, head of markets and wealth management solutions for Asia at Julius Baer. This caused atypical market conditions, further complicating investment strategies.

Prominent hedge funds, including British-based Winton, Beijing X Asset Management, Techsharpe Quant, and Shenzhen Chengqi Funds, also faced setbacks from the market's unexpected shift.

The Strategy’s Downfall

Hedge funds like Power Asset were affected as they sold increasingly popular "call" options at much lower prior prices. Options arbitrage, once their best-performing strategy, struggled as market conditions changed. Power Asset aimed to profit from minor pricing discrepancies between derivatives, operating on a strategy that previously had a high success rate.

> "When an option contract is under-priced, we buy; when it is over-priced, we sell," said Power Asset founder Chen Pao during a July roadshow. The strategy had a historical winning chance of around 90%. However, it also faced what is termed 'tail risk' from rare extreme market events, managed through quick losses cuts and diversified investments.

Other investors described this approach as risky, with Robin Zhang of Winfield Global stating, "You're basically betting you win 95% of the time, but there's also a 5% chance you blow up." Last month’s market surge proved this likelihood as it caught many investors unprepared.

While the market has since stabilized, traders anticipate another round of volatility as Beijing provides more details on its fiscal package and with tension surrounding the U.S. elections.

Jason Zhang, a Shanghai-based hedge fund manager, suggested using a straddle option strategy to navigate this uncertainty. "If you don't know the direction of the market but anticipate significant movement, this may be an effective strategy."

With Republican frontrunner Donald Trump seen as a potential catalyst for market volatility, there remains concern among hedge fund managers who recently faced losses in futures and options trading.

> "A cloud still hangs over many hedge fund managers who recently suffered losses from futures and options trading."

$1 = 7.1260 Chinese yuan renminbi.