The Qin Shi Huang redux

Mon May 23, 2011

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China managers are breaking free from their pre-crisis stigma of beta chasers and evolving as sophisticated hedge fund managers


By Aradhna Dayal

nullIn Beijing for one of the prominent annual hedge fund gatherings in Asia, and amidst tête-à-tête with some of the best brains in Chinese hedge fund space, I couldn't help but marvel at a quiet revolution that is taking place there. China managers are breaking free from their pre-crisis stigma of beta chasers and evolving as sophisticated hedge fund managers, with a focus on fundamental investing, downside protection and some pretty savvy moves on the shorting side.

Much of it can be attributed to the enhanced maturity of the Chinese markets, which, as one long-term industry observer put it jokingly, was dominated by "reasonably dumb money" until recently. A high degree of speculative retail participation and the resultant volatility in the market meant that classic hedge fund techniques were difficult to execute and generate alpha in the mainland markets. But that is changing rapidly, and a new wave of "some very smart money" is making its way into the local markets, both from western institutions as well as the rapidly emerging private funds that are making their mark in China. Stocks are getting more mature too, and there is an increased transparency and liquidity, all of which lends itself much better to classic hedge fund strategies.

The biggest credit, however, goes to the China-focused managers themselves. They seem to have taken stock after the disastrous 2008, a period characterised by huge drawdowns, gating and capital outflows from China funds, and adopted not just more measured investment styles but also the operational institutionalisation that is sweeping through the Asian hedge fund landscape.

It could be said to be much like the history of the visionary first Emperor of China, Qin Shi Huang. He tamed the warring states that were China into one unified country (and went on to not only build the Great Wall but also introduce revolutionary concepts such as economic acceleration through infrastructure development, free thought leadership and currency standardisation). Likewise, the new-age China hedge fund managers are integrating best practices within their operations and in the process putting China hedge fund investing on the world map. In short, a Qin Shi Huang redux.

Many of these managers have spent the past three years building out strong research teams, often on the ground in China, with a focus on fundamentals, identifying long-term investment themes and stock picking to generate alpha, rather than relying largely on market swings. Another key development has been the incorporation of strong risk management systems - as the China managers realise that preserving capital and downside protection is probably just as important as producing returns, especially in today's uncertain macro environment.

Finally, we are seeing the emergence of some highly-skilled managers on the short side in the China equity long/short space. They are actively trawling for shorting ideas and focusing on individual stocks to glean alpha, rather than just using index options and futures.

This is nothing short of a landmark event, for China has always been viewed as a fundamental long-term growth story that does not lend itself well to shorting. However, many of the second-generation China hedge fund specialists, many of who have launched their own vehicles or rebuilt assets in the past couple years (such as Dragon Billion, Trivest, Pinpoint, Triskele and Galaxy) are breaking this myth and producing uncorrelated returns -as well as fast becoming the benchmarks for the China-focused space.

There is also a diversification by strategy and asset classes; while previously the China hedge fund space was dominated by long/short (read primarily long-biased) funds, a new breed of China managers specialising in credit, event-driven and even quantitative investing are making their mark.

The numbers say it all. Despite the tough markets of 2010 and early 2011, a large percentage of China managers have held up pretty well (the AsiaHedge China Index was up a respectable 2.77% for April 2011 and 1.48% year to date) and several investors I spoke to were pleasantly surprised at how several stayed in positive territory even during down markets.

All eyes continue to be on China with the expectations of an economic soft landing and the internationalisation of the renminbi. AsiaHedge brings you an exclusive Q&A with Isaac Souede, chairman and CEO of the Permal Group, on how investors are shifting gears back to emerging markets in light of that.

The May issue of AsiaHedge also comes with an in-depth feature on Japan throwing open unique alpha opportunities post the March earthquake and tsunami. Finally, we bring you our annual Prime Broking Survey that shows how key players are reshaping the market shares in Asia.