Long-bias bulls to invest in China’s shops via new trend index

The new MSR China Trend-Plus Index, from New Jersey index advisory firm MSR Indices, models the historical returns investors could have received had they applied MSR’s proprietary trend-following model to a range of commodity and equity index futures listed in exchanges in mainland China since the end of 2014. Even accounting, as one should, for the limitations of backward-looking hypothetical simulations as a methodology, the results are impressive, and they offer hope for non-Chinese bulls who are hopeful about China’s economic future and want to invest accordingly. In September 2019, MSR Indices, created the MSR Platform, an institutional investment platform designed to offer investors access to the returns of MSR Investable Indexes, including now the MSR China Trend-Plus Index. In January 2021, asked to explain MSR’s approach in broad terms, Michael Rulle, founder and CEO, told Alternatives Watch, “We think in terms of risk parity and risk targeting, and of three basic trading styles.” The styles he had in mind were reversal, long-only investing and trend following. The new China Trend-Plus index is, as its name suggests, oriented toward investors who want to pursue a trend-following strategy. To go a little into the analytical weeds: the index works on MACD, “moving average convergence/divergence,” in determining what the trends are and in following them. The index is also a risk parity system in that it includes a target volatility algorithm at every level of portfolio construction as well as an aggregate margin limit. Although not long-only, it is long-biased. The risk parity positions are netted against the trend-following positions so that, while the model can and does go short equities in specific situations, there is a built-in bias toward long positions. Matt Brown, president and chief operating officer of MSR Indices, explained in a recent conversation that human involvement in specific portfolio decisions within the model is … detached. There is no human portfolio manager putting his/her fingers on a scale to ensure that the bias toward the long side is enough. The bias exists in the algorithms. In a recent white paper on the index, shared with qualified eligible persons, MSR laid out monthly excess return statistics. The simulation, of how a hypothetical investor tracking its index would have fared, ran on data from between December 31, 2014 and March 31, 2021. It shows that by the end of 2016, an investor in this index would own close to 1,900% of the principal one had put in at the start of that period. By early 2020 that number would be about 2,400% if the initial investment had been yuan denominated, somewhat less -- but still above 2,000%, if it had been dollar denominated. As of the end of the first quarter of this year, the percentage of the principal would be above 3000% (yuan denominated) or above 2600% (dollar). These figures are all net of a 1.5% management fee. The trend-following and the risk-parity models used by this index were developed subsequent to the global financial crisis of 2008, and were in essence complete by 2014, six years before the creation of the index itself, in 2020. Interestingly, the hypothetical recreation of the model’s results shows a significant downturn in March 2021, a negative “excess return” of 3.25% given a dollar denomination or of 3.14% given a yuan denomination. It isn’t clear what happened in March that caused this. Clearly, there were some reversals that defeated the trend following that month. This may have been the consequence of a slowdown in the growth of the trade surplus. In March 2021, China’s imports in U.S. dollar terms rose 38.1% year-on-year, which was above the 23.2% increase analysts had forecast. Meanwhile, China’s exports fell short of analyst expectations. The managers of a proposed new Global Alpha Hedge Fund want to be the first or among the first hedge funds to take advantage of the new possibilities for foreign investors in China. They are now engaged in what COO Brown called a “virtual road show.” What is news about the new hedge fund is the prospect it offers of uniting westerners’ money and strategies with Chinese opportunities. Foreign investment in the People’s Republic has always been subject to severe limits. Some of those limits are only now beginning to lift, in ways that make this index important and timely. In November 2020, in particular, the China Securities Regulatory Commission announced the opening of the country’s futures exchanges to foreign investors. Brown noted that some of the biggest commodity trading advisors and hedge funds, including Winton and D.E. Shaw, have already been in China, trading Chinese futures for Chinese investors. As Brown explained, though, the opening to foreign investors was accomplished by the expansion of an older program, one providing for trading by Qualified Foreign Institutional Investors (QFII). Previously QFIIs had only been allowed to invest in stocks, bonds, and stock index futures. But the November change in regulations combined the QFII with a similar yuan-denominated program, RQFII, and the combined program did not inherit the old restraints. Foreign institutional investors can now, in principle, invest in over-the-counter securities on the New Third Board, private investment funds, asset-backed securities, financial futures, commodity futures, securities lending, securities financing on stock exchanges, options, margin trading, and bond repo transactions. Since then, though, Brown cautioned, “what’s happened is a little frozen.” A lot of players have been waiting for the exchanges to write their implementing rules. The new hedge fund proposes to allocate 50/50 to China on the one hand and to the G7 countries on the other. It says it will be “the first futures trading strategy” to make such an allocation “that we are aware of.” Further, its managers expect that the capacity constraints of the Chinese markets will serve it as a “moat,” limiting further entrants. “Capacity constraints in China will make this extremely difficult for biggest firms to replicate” what it is planning to do for its investors.

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