As the Year of the Dragon began, the micro-cap market showed a strong rejuvenation following a gloomy period during the pre-holiday seasonOn February 22, micro-cap stocks surged once again, with the CSI 2000 Index and CSI 1000 Index rising by 2.55% and 1.54%, respectivelyNoteworthy gains were seen across various stocks, including Guangha Communication, Kexiang Co., and Tongxing Technology, with several hitting their daily limit of 20%. This resurgence marked a dramatic shift in investor sentiment towards these smaller-cap equities.

Throughout the early weeks of February, micro-cap strategy funds experienced significant recoveries after suffering considerable losses in late JanuaryAccording to Wind data, from February 8 onwards, several micro-cap funds rebounded by over 20%, indicating a potential recovery of prior losses within the sectorInterestingly, despite these gains, there was a notable outflow of capital from both the CSI 2000 and CSI 1000 ETFs during the same period

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This trend revealed a wavering confidence in the small-cap style among investors, as the exit from these ETFs suggested a cautious approach amid the fluctuating market conditions.

To offer more perspective, let's analyze the performance of specific fundsThe micro-cap style funds, including Zhongxin Baosheng Multi-strategy and Nuon An Multi-strategy, saw impressive rebounds exceeding 20% between February 8 and 21. For instance, on February 8, a notable shift occurred when the Changjin Hexin Qifu Preferred Fund surged by 13.32%, while others like Zhongxin Baosheng and Great Wall Dynamic Quant had daily increases of over 10%. By February 21, Dongfang Quantitative Growth had a substantial single-day increase of 7.08%. Such significant increases in a short time underline the volatility and responsiveness of these funds to market fluctuations.

Focusing on one fund, Changjin Hexin Qifu Preferred Fund stands as a quintessential micro-cap fund

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By the end of 2023, its five largest holdings included Jugeshun, Xianglu Tungsten, Xinlong Health, Meng Tian Home, and Chenhua Co., all of which have market capitalizations below 5 billion RMBNotably, Jugeshun has seen a remarkable recovery of over 20% since February 6. Similarly, Zhongxin Baosheng’s investment portfolio also comprises micro-cap stocks with market capitalizations below 5 billion RMB, including major holdings like Boyan Precision and Jianke Machinery, both of which have shown impressive recoveries from their lows.

Despite the recent reversals and recoveries, it is crucial to acknowledge the substantial volatility that has characterized the micro-cap marketIn January, a rapid shift in market sentiment led to significant pullbacks within micro-cap strategy funds, with many experiencing declines approaching 50%. This retracting trend was starkly demonstrated when some funds even faced single-day declines exceeding 15%. While the recent resurrection in stock prices has aided in restoring some fund values, the year-to-date performance for many micro-cap strategy funds remains in negative territory

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For instance, as of February 21, the Jin Yuan Shun An Industry Selection's year-to-date decline still exceeded 40%, with several other funds remaining down by more than 30%.

Compounding the complexities of this market situation are the significant outflows from key ETFs that typically represent small-cap strategiesSimultaneously, as micro-cap stocks underwent rapid rebounds, the CSI 2000 ETF and CSI 1000 ETF faced substantial net capital exit, indicating an underlying cautiousness among investorsStatistical analyses revealed that all 14 existing CSI 2000 ETFs have had a cumulative average rebound of approximately 7.13% since the Lunar New Year; however, this was coupled with a significant total outflow of nearly 16.09 billion RMB in investmentsIn fact, 11 of these 14 funds showed decreased share totals, collectively reducing over 20.7 billion sharesParticularly, the Southern CSI 2000 ETF and the Huatai Baichuan CSI 2000 ETF alone recorded outflows of 9.72 billion and 8.75 billion shares, respectively.

Analogous trends appeared within the CSI 1000 ETF sector, revealing that out of 17 ETFs, 8 exhibited reduction in shares since the New Year’s celebrations, leading to an overall decrease of about 789 million shares and net outflow estimated at approximately 1.5 billion RMB

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Furthermore, many actively managed micro-cap strategy funds began lifting their previously imposed purchase limitsNoteworthy among them were Zhongxin Baosheng Multi-strategy, Guojin Quantitative Multi-Factor, and Dachen Jingheng Mixed Fund, all of which re-opened for new investments, hinting at optimism for the future market conditions.

Industry experts attributed these movements to a combination of factorsOn one hand, fund managers appeared to be anticipating a bullish market outlook by adjusting limits to attract fresh investorsConversely, there was also a recognition that, following net value declines and a drop in share numbers, there was renewed capacity for strategies to accommodate larger investment inflows.

The question of where micro-cap stocks will head next looms largeThe ongoing capital exit from ETFs arguably reflects an erosion of confidence in the small-cap sector

Recent declines in both public and private quantitative funds have exacerbated scrutiny on micro-cap stocks, pushing them once again into the limelight of market speculationAnalysts from Guohai Securities posited that micro-cap stocks often rally during periods of market turbulence and uncertainty, as thematic trends attract the attention of speculative capitalShould a continued preference for larger-cap stocks ensue, micro-caps may face ongoing challenges in overcoming their performance hurdles.

On the other hand, market sentiment remains dividedJiang Feng, the fund manager of Zhongxin Baosheng Multi-strategy, articulated that since the beginning of the year, fluctuations among small to mid-cap companies have been pronouncedA historical analysis indicates that confidence in economic and industry trajectories is pivotal in influencing style rotations between large and small capsWhen trends point towards economic recovery, plentiful industry investment opportunities, and ongoing technological advancements, small-cap stocks may indeed reassert themselves favorably.

Contrastingly, Wei Fengchun, Chief Economist at Changjin Hexin, expressed skepticism regarding the sustainability of micro-cap strategies

He highlighted that the dynamics of market funding have shifted quietly, suggesting that speculative focus has increasingly moved towards larger, value-focused stocksThis transition from a "barbell strategy" underscores a fundamental market reshaping, distancing from previously crowded micro-cap investments.

Interestingly, several fund managers have noted a cyclical pattern in the rotation between large and small cap stocks in the A-share market, emphasizing a recurring 3-4 year rhythmIn recent years, the mid and small-cap segment has been elevated, leading to the current perception of larger cap stocks offering comparatively attractive value propositionsA general trend observed is that during the last stages of a market downturn, both large and small caps undergo a period of broad declines, signaling potential market stabilizationThis insight underscores the complexity of navigating micro-cap investments amid shifting market paradigms.