AI trading is too crowded! Global funds are beginning to diversify their allocations: Are Chinese stocks back in the spotlight?

There are signs indicating that global investors who wish to diversify their investments outside the crowded AI trades in the US, Japan, and South Korea are increasingly turning their attention to Chinese stocks and related derivatives... In recent weeks, clients have shown rising demand for call options and swap contracts linked to the CSI Index, as observed by trading departments from Barclays Bank to UBS Group. Meanwhile, an increasing number of strategists are recommending positioning for returns through derivatives trading, particularly in the mid- and small-cap stock sectors. According to analysis from BNP Paribas and Bank of America, the main driving forces behind Chinese stocks include: ongoing capital market reforms that continuously support a gradual bull market, the accelerated realization of technological self-reliance, and the overall improvement in the profitability outlook for the hardware sector. In a report titled Chinas CSI 500 Is Better Choice to Diversify AI Trade by UBS, the bank specifically points out that the CSI 500 Index serves as an alternative investment target for investors seeking to diversify their risk exposure. Turning Eyes to China Currently, despite a recovery following its worst monthly performance since 2016 in July, the CSI 1000 Index is still 16% lower than its peak in May. At the same time, the implied volatility, a key parameter in option pricing models, has fallen back to its one-year average, making derivatives trading more attractive. This is an ideal trading moment because market sentiment is somewhat tense, says Lars Naeckter, head of Asian Pacific equity derivatives research at Bank of America. He suggests establishing a call option spread on the CSI 1000 Index. Instead of rushing to buy stocks or futures, choosing options is wiser, especially when pricing is favorable for you. Sooner or later, a catalyst will appear, and tactically taking positions before a rally often proves more cost-effective than reacting passively, Naeckter points out. At Barclays, the trading desk has also noticed increasing customer interest in call option spreads on domestic Chinese indices, with many investors expecting gradual market gains rather than sharp rises. Kaanhari Singh, head of equity liquidity derivatives sales for Asia Pacific at Barclays, noted that relative to recent historical performance, excess return trades linked to the CSI 300 and CSI 500 indices are quite attractive. In recent months, we've seen growing interest from investors in bullish strategies on Chinese A-shares, Singh stated. This partly reflects that as the valuations and return expectations of some of the hottest investment themes in the global market have come into question, investors are seeking to diversify their sources of stock returns. A Good Place for Diversification Meanwhile, UBS's sales and trading department noted on August 30 that the weeks largest derivatives inflow in Asia came from bullish bets on the CSI Index. The department has observed substantial requests for long swap trades concentrated on the CSI 300 and CSI 500 indices, along with call option combinations. BNP Paribas stated that as the Chinese government promotes self-reliance in the technology industry, the importance of tech stocks within Chinese indices is increasingly highlighted, which helps attract investors. Currently, technology stocks have become the highest-weight sector in the CSI 300 Index, with increased weightings in mid-cap and small-cap indicesCSI 500 and CSI 1000. In the U.S., last Friday, a trader purchased a large number of call options on the KraneShares Chinese Internet ETF (KWEB), wagering that the fund's price would recover to earlier levels this year. Due to the unique ecosystem of Chinese stocks, the mainland market offers distinctly different investment opportunities in the field of artificial intelligence. Therefore, compared to global AI trades, this naturally creates an effect of diversification, stated Jason Lui, head of equity and derivative strategies for Asia Pacific at BNP Paribas. Today, this more controllable volatility characteristic has also encouraged both domestic and foreign institutional investors to engage in more mid-term asset allocation. In fact, even some star fund managers in the U.S. are starting to shift their focus more towards overseas markets, including China. A top-performing fund manager at PIMCO recently bet that the next winner in the AI boom would not emerge from the crowded U.S. tech giants, but would turn to Asian equipment suppliers, Chinese financial stocks, and healthcare stocks. Emmanuel Sharef, who manages PIMCOs flagship fundthe 60/40 Balanced Income and Growth Fundstated that as spending in the AI field ramps up, many large U.S. tech companies are facing increased debt burdens and uncertain profit outlooks, which has diminished their attractiveness. The fund has now reduced its holdings in the seven largest U.S. tech stocks. PIMCO currently maintains an overweight rating on Asian markets, citing strong earnings growth in Asia and investment in downstream businesses in the AI supply chain. Sharef indicated that he expects this view to continue as long as earnings growth remains robust. The scale of capital expenditure in the AI sector is enormous, he said. This means that demand for semiconductor components, cooling equipment, cabling interconnects, optical equipment, power supplies, construction materials, metals, and all materials needed for data center construction will grow significantly. In China, the fund's largest sector allocation focuses on financial stocks due to their relatively low volatility. He also views materials stocks positively. The MSCI China Materials Index has risen about 7.1% in the past month, outperforming most major sector indices, as rising gold and copper prices have helped the index transition from one of the worst-performing sectors this year to one of the market leaders. He also added, Chinese resource extraction and materials companies are very important, not only for data center construction but also for rare earth resources. This article is sourced from Caixin, edited by GMTEight: Wang Qiu Jia.