Jasper Capital Fundamental Thoughts (Part One) | Quantitative Fundamentals: A Niche Path Less Travelled

In 2013, the American hedge fund AQR published an academic paper titled Buffett's Alpha, in which the authors conducted a quantitative analysis of Warren Buffett’s investment decisions over the years and developed a mathematical model to characterize his stock-picking preferences.

Interestingly, the authors attempted to deconstruct the "Oracle of Omaha's" moneymaking logic using six categories of factors: quality, beta, market, size, value, and momentum. An investment portfolio modeled on these factors, following a “Buffett-style” approach, significantly outperformed market indices over the long term, with performance comparable to Berkshire Hathaway itself. This paper demonstrates the effective combination of quantitative thinking and subjective fundamental stock selection. It raises an intriguing question: if we have a sufficient sample size, can we replicate the stock-picking logic of outstanding fundamental investors using quantitative models and consistently beat the market? This leads us to the topic at hand: quantitative fundamental analysis.

Chart 1: Performance of the stock market, Berkshire Hathaway, and the simulated Buffett-style portfolio.

Quantitative Fundamentals: A Road Less Traveled

Quantitative fundamental strategies experience a slower decay in alpha and can handle larger capacities. However, they remain relatively niche within China's quantitative hedge fund space. Due to the high difficulty of research and modeling, managers often use these strategies as a supplement to price-volume strategies. Quantitative fundamentals are like an unattainable ideal—everyone acknowledges their potential, yet few can truly master them.

Effectively integrating quantitative and fundamental thinking requires a complementary balance of internal and external skills. The universe breadth of a active fundamental equity manager is typically narrow, while their research dives deep into the operating models of the companies that they invest in. In contrast, quantitative investors use their data advantage to develop more generalized models across a broader range of stocks with more diversified alpha sources. However, without a deep understanding and forward-looking judgment of both macro and microenvironments, the breadth of information may fail to compensate for the lack of depth in individual stock research and could even lead to pitfalls.

Take financial indicators as an example: financial data fields are abundant, but only investors who have deeply studied the industry and understand accounting details can discern which fields accurately describe a company’s true fundamentals. Moreover, the methods of financial fraud are constantly evolving, with many financial statements hiding intricacies. For instance, some companies may bury inflated revenues within different balance sheet items, such as inventories in agriculture or goodwill and intangible assets in TMT sectors. Capturing these opportunities amidst layers of obscurity requires a deep understanding of the roles played by different accounting categories.

Jasper’s Quantitative Fundamentals: The "Iron Triangle" Team Balancing Breadth and Depth

As a quantitative manager that has consistently balanced fundamental and price-volume factors since 2017, Jasper has accumulated substantial experience on this niche path. The company's "Iron Triangle" fundamental team has developed a strong rapport over the years, with members boasting interdisciplinary backgrounds in neural networks, artificial intelligence, computing, and accounting, ensuring both research breadth and depth.

Chart 2: Jasper’s quantitative fundamentals research team.

In terms of breadth, the company’s proprietary IT systems and intelligent research platform track various databases in real-time, including industry and corporate data, extracting core information from vast datasets. For industries that are hard to predict, we also build separate models using alternative data, complementing the overall market model to ensure strong stock-picking capabilities across different sectors.

The advantage in depth is reflected in the precision and differentiation of research. To maintain the long-term effectiveness of our strategy, we must explore more "uncharted territories." First is the deep analysis of corporate characteristics. Our team's diverse academic background ensures a high sensitivity to information about listed companies. For example, in the case of the earnings quality factor, we have built a series of financial indicators based on a deep understanding of accounting categories such as cash flow, receivables/payables, related party transactions, and inventory costs, resulting in an "earnings shock detector." This detector can automatically spot "cosmetic traps" in financial data, identifying companies that have manipulated their reports, helping the model avoid stocks with high potential for earnings shocks.

Furthermore, attention to the details of factor research is crucial. Below, we use the analyst factor as an example to illustrate the uniqueness of Jasper’s fundamental research. Analyst report indicators reflect the marginal changes in market expectations for company performance. There is a prevailing view that the analyst factor has been in decline since 2021—for instance, the performance of analyst coverage factors has seen a significant pullback since 2021, indicating a reduced market response to analyst expectations.

Chart 3: Analyst coverage factors have underperformed overall since 2021. Data source: Dongfang Securities.

Chart 4: The live performance of Jasper’s analyst-related factor, showing consistent predictive value. Data source: Jasper Capital.

Analyst-related Factor_Pure Alpha

We further dissect and restructure the analyst factor. For instance, as market participants, analysts themselves may make irrational decisions. Some analysts, upon seeing a significant rise or fall in a stock before publishing a report, may subjectively adjust their forecasts—this can be understood as analysts being influenced by short-term price-volume changes in the stock.

Therefore, analyst reports are further broken down into two parts: forecasts based on in-depth company research and predictions influenced by price-volume movements. The latter, often irrational, is filtered out. By extracting the essence of analyst reports and combining it with our own price-volume research, our model becomes more "objective" than the analysts themselves, allowing us to select higher-quality companies.

Conclusion

Quantitative investing is like an autopilot ship. Most of the time, we can trust the intelligent system to steer the course. But when the seas are rough beyond the system's recognition limits, an experienced navigator is needed to keep the ship on track. Fundamental information is akin to this navigator, preventing the ship from veering off course.

Today, globally renowned asset management institutions rarely rely solely on price-volume factors for investment decisions. As China's market matures and efficiency improves, the difficulty of extracting excess returns from price-volume strategies will gradually increase. We also see regulators repeatedly emphasizing the trend of lowering the frequency of quantitative strategies. As a manager who has deeply cultivated this field for nearly a decade, we believe that quantitative fundamentals will fill the missing pieces in price-volume strategies, ushering in the next golden era of quantitative investing in China.

In a Declining A-shares Market, Market Neutral Strategies Are the Last Defender of Liquidity

Small-Cap Stocks Plummet Amid Weak Market Sentiment

Since the beginning of 2024, the Chinese stock market has been particularly brutal to small-cap stocks, with the CSI 1000 and CSI 2000 indices, representing the broader spectrum of smaller companies, leading the decline. As of late July 25, these indices have plummeted by 21.31% and 28.20%, respectively, significantly underperforming the broader market.

The sustained downturn has been exacerbated by a notable reduction in the equity positions of active equity funds, which have experienced two consecutive quarters of decline in holdings, coupled with substantial redemption pressures. This confluence of factors has led to a marked decrease in trading volume since May, triggering a prolonged market downturn.

Source: Choice Data

The Investor's Dilemma: To Sell or Hedge?

Consider the predicament of an investor who, in the face of declining markets, decides to reduce their risk exposure. The simplest approach might be to sell off their holdings. However, such actions contribute to a vicious cycle: selling leads to price drops, which further deteriorates market sentiment, prompting even more selling—thus reinforcing the downward spiral. This phenomenon, known as a “cascade of selling”, forces every remaining bull to reluctantly become a potential bear. As market liquidity dries up, even relatively small sales can significantly impact prices. Breaking this cycle usually requires either a major positive macroeconomic development or the influx of substantial new capital.

But is there an alternative that allows risk reduction without triggering such a destructive feedback loop? The answer is yes.

Hedging: A Smoother Path Through Market Turbulence

Rather than selling off stocks, investors can use derivative instruments like stock index futures to hedge their positions. These instruments track specific indices—such as the CSI 300, CSI 500, and CSI 1000—and can be used to offset risk by shorting futures contracts equivalent to the market value of their stock holdings. For example, on a day when the market falls by 2%, the decline in stock holdings could be offset by a corresponding gain from short positions in index futures, thus significantly mitigating overall risk and allowing investors to hold onto their long positions with greater confidence.

However, this approach is not without its challenges. For hedging to be effective, the composition of the stock holdings and the index futures must be closely aligned. For instance, hedging a portfolio of bank and blue-chip stocks with CSI 1000 futures would be ineffective. Furthermore, hedging comes at a cost, with annualized expenses typically ranging from 5% to 10% or more. As a result, successful hedging strategies require not only careful selection of stocks that outperform the index but also the ability to cover these costs.

The Role of Market Neutral Strategies

In the A-share market, market-neutral strategies play an irreplaceable role in providing liquidity and ensuring deep value discovery, especially during market downturns. These strategies, predominantly offered by quantitative funds, are designed to be insensitive to market movements, focusing on long-term stock selection capabilities and maintaining consistent, superior performance that transcends index benchmarks. By steadfastly holding onto their long positions, irrespective of whether they are large-cap or small-cap, growth or value stocks, these funds ensure a healthier market ecosystem.

Unfortunately, the current scarcity of stock index futures in the A-share market results in prohibitively high hedging costs, which in turn limits the overall capacity of market-neutral strategies. This has contributed to the dominance of long-only products in the asset management market, creating an imbalance that leads to widespread losses and subsequent redemptions during market downturns.

Misunderstanding Derivatives: The Case for Education

There is often a misconception among retail investors that derivatives are the villains in a declining market. However, the reality is that these instruments, when used responsibly, provide essential risk management tools that can prevent the kind of self-reinforcing sell-off cycles witnessed this year. For example, under regulatory guidelines, asset managers are prohibited from holding naked short positions, ensuring that short futures positions do not exceed the market value of long stock positions. The absence of sufficient hedging tools often forces investors to reduce stock holdings collectively, thereby exacerbating the “cascade of selling” that was so vividly demonstrated by the performance of small-cap stocks in 2024.

In conclusion, the responsible and scientific use of hedging tools like stock index futures and diversified strategy offerings within the A-shares market is vital for maintaining market stability. We have long recognized the importance of incorporating these instruments into market-neutral strategies. By doing so, we can not only diversify revenue streams and spread investment risk but also help investors navigate the complex and volatile financial landscape to discover and seize genuinely valuable investment opportunities.