China's "E*trade Babies" Wiped Out In Market Crash

What do you get when a bursting equity bubble meets 5X leverage, structured finance, semi-literate banana vendors, and fund "managers" with less than one year of experience?

Harrowing margin calls, panic selling, and, in the end, massive losses. 

As WSJ reports, the relentless, limit-down trading in Chinese stocks that unfolded last week and continued into Monday (despite the PBoC's best efforts to arrest the slide with an emergency rate cut) has wreaked havoc on China's rookie money managers and their unsuspecting clients with losses amounting to as much as 80% in some structured funds.

In China’s market bust, rookie fund managers and their investors are among the biggest losers.

 

The 10 worst-performing funds the past month are so-called structured funds, which are essentially leverage plays tracking some indexes, according to Howbuy.com, a Chinese fund tracker. The three worst performers fell by an average of 77% during the period.

 

Those funds were all led by professionals with less than a year of fund-management experience, according to details on Howbuy.com. 

 

China’s mutual-fund industry was booming until recently. Structured funds were a star performer during a yearlong bull market. But they also have done poorly during the current market decline, which began over two weeks ago. The Shanghai Composite Index closed up 5.5% Tuesday, paring recent losses, but is still down 17% from a high in June. 

 

Similar to leveraged exchange-traded funds in the U.S., structured funds can give investors two or three times the performance of an index. When markets are falling, though, these funds rapidly lose value, and can accelerate a selloff... 

 

During the run-up, Chinese fund-management companies rushed to issue structured funds... 

 

The problem has been finding mutual-fund managers to head these new funds. In recent years, many experienced mutual-fund managers have left their jobs to start their own private-equity firms, which are more profitable. “A lot of junior people were promoted to become fund managers,” said Haibin Zhu, chief economist for China at J.P. Morgan Chase & Co.

Here is a visual summary of the above:

As discussed in "The Biggest Threat To Chinese Stocks: Shadow Lending Crackdown," the structured vehicles that have played a role in allowing retail investors to skirt margin restrictions were partly (or even largely) responsible for the outsized losses posted by China's greenhorns. Here's WSJ again:

Retail investors and even some institutions like structured funds because they have earned outsize returns and it is an easy way to leverage their investments without having to borrow from securities firms or banks.

 

The funds are usually divided into two or more tranches. 

 

With structured funds, the B-tranche is typically forced to sell stocks and lower leverage in a falling market, to protect the interest of the A-tranche fund investors. This has accelerated stock declines and exacerbated B-tranche losses.

 

The May 27 launch of the 246-million-yuan ($39.6-million) Peng Hua High Speed Railway Fund, the third-worst performer the past month among China’s 2,879 mutual funds, according to Howbuy.com, is especially ill-timed. High-speed rail was a hot investment theme, but many of those stocks are now down 60% from their recent peaks.

 

The Peng Hua High Speed Railway Fund is managed by Jiao Wenlong. Mr. Jiao... He became a fund manager on May 5, the prospectus said.

Because we couldn't possibly come up with a better way to encapsulate the fantasy being sold to China's millions of newly-minted day traders by the country's newly-minted fund managers who apparently have just as little experience managing money as the people whose money they are managing have trading stocks, we'll leave you with the following from the aforementioned Jiao Wenlong: 

“Invest in the fund to leverage your dream.”