China's launch of small-cap derivatives spawn new strategies, funds

SHANGHAI (Reuters) - Futures and options based on China's small-cap CSI 1000 Index started trading in Shanghai on Friday, spawning fresh products and strategies from fund managers seeking to capitalize on the new hedging instruments. The derivatives, which debuted on the China Financial Futures Exchange (CFFEX), offer investors tools to manage risks in a basket of 1,000 mostly innovative small tech companies, drumming up interest in the sector. Four exchange-traded funds (ETFs) tracking CSI 1000 also launched on Friday, seeking to raise 8 billion yuan ($1.18 billion) each. In the hedge fund space, two products tracking the index and seeking enhanced returns were created this month, according to the fund association. "The new derivatives will likely boost investors' confidence to hold small caps," said Chen Hongting, option investment manager at Trading Art Association. Previously, investors were reluctant to buy volatile small stocks in the absence of effective hedging tools, Chen added. More strategies based on the CSI 1000 Index futures and options are expected to emerge, potentially increasing the size and liquidity of CSI 1000 Index ETFs, according to Guosheng Securities. China's securities regulator said on Monday that launching CSI 1000 Index futures and options is a key step toward deepening capital market reforms, and can help further satisfy investors' need to hedge risk. It is an especially welcome development for China's rapidly growing hedge fund industry, which builds various quantitative strategies with the use of derivatives. Global hedge fund houses include Bridgewater, Winton, Man Group and Two Sigma have all entered China's market. The four ETFs launched on Friday are managed by E Fund Management Co, China Universal Asset Management Co, Fullgoal Fund Management Co, and GF Fund Management Co. "The ETFs can bring more money into those growth companies and offer retail investors a channel to buy small-cap stocks," said Ade Chen, General Manager of Fund Investment. He also told Reuters his firm is going to find arbitrage opportunities using the CSI 1000 Index futures, as higher volatility in small caps potentially generate higher returns for his strategy. Previously, the CFFEX only had three types of stock index futures products, tracking the mega-cap SSE50 Index, the blue-chip CSI300 Index and the small-cap CSI500 Index, respectively. Fund managers can also design structured products based on the new derivatives, or use them as hedging tools in the so-called market neutral strategy, Zhang Chao, an analyst said at a GF Fund Management roadshow.

($1 = 6.7665 Chinese yuan renminbi)

(Reporting by Jason Xue and Brenda Goh, additional reporting by Samuel Shen; Editing by Kim Coghill)

By Jason Xue