Chinese Hedge Funds set for Growth

Hedge funds poised to pile into China via ‘connect’ channel

When the landmark Hong Kong-Shanghai equity link debuts on Monday, a class of investors that China has kept at arm’s length until now – hedge funds – are expected to plunge into mainland shares.

And rules for the coming stock “connect” mean that these more aggressive players will likely be ahead of the pack, as they are not constrained by operational and legal issues that will keep many long-term institutional investors from participating.

The expected influx of foreign hedge funds, who bring a shorter-term focus, will cause jitters about increased volatility in China’s already wild stock market.┬áChina has favoured long-term asset managers when allocating quotas under an existing investment programme known as QFII, forcing hedge funds to “rent” quotas from banks.The opening-up to hedge funds creates a dilemma for Beijing, torn between a desire to protect its market’s heavy retail investor base and liberalise its capital account.

Beijing aims to control inflows and volatility hikes by imposing a daily quota of 13 billion yuan ($2.2 billion) plus restrictions on short selling. Analysts say mainland regulators will monitor activity carefully.

“The Chinese government has been worried about protecting its citizens, as hedge funds are more sophisticated,” said Anthony Tse, chief executive of Hong Kong-based hedge fund Pangu Capital. “But letting in these firms is part of any evolution of a capital market.”

For sure, hedge funds eagerly await the scheme’s launch. “They are the most raring to go,” said a broker at a global bank in Hong Kong. “As soon as it opens, they will be straight in.”

Benjamin Chang, chief executive of LBN Advisers, a Hong Kong-based hedge fund, said his firm and his peers will “definitely” participate, predicting that the daily allowance “will pretty much get filled-out”.

The link will let international investors trade Shanghai ‘A’ shares via Hong Kong’s stock exchange while mainland investors can deal in Hong Kong ‘H’ shares via the Shanghai Stock Exchange, subject to quotas both ways. Daily purchases of Shanghai stocks are limited to about 19 percent of the exchange’s average daily value of securities traded, according to Goldman Sachs.

Data from consultancy Eurekahedge shows 35 hedge funds have set up this year in Hong Kong, taking its number to 495, the most since before the global financial crisis.

MAINLAND ROADSHOWS

Funds focusing on fundamental stock-picking and relative value strategies that exploit price differences between companies listed in both Hong Kong and Shanghai are expected to be first out of the gate.

These funds look to snap up winners before long-term investors, and position themselves before the gap between Hong Kong and mainland stocks – which has narrowed significantly in recent months – closes further.

The head of equities at a European bank said his team had been flat-out arranging mainland road shows for hedge funds. The broker at a global bank said several hedge fund clients had hired research analysts to trawl through China’s mid-caps.

Pangu’s Tse said quality consumer stocks such as liquor-maker Kweichow Moutai Co. and dairy Inner Mongolia Yili Industrial Group Co., plus some aerospace and automobile companies, look attractive.

Some conservative asset managers, including Vanguard, have said technical issues, particularly Shanghai’s unusual trade settlement process, will keep them from participating at the start. The managers say Shanghai’s settlement rules could result in signalling their trading intentions to the market.

Another issue that could dampen initial volume is uncertainty over the scheme’s tax rules. Chang of LBN Advisers said he does not see these matters as obstacles, adding: “You have to do what you have to do.”

Source: Reuters