The principal fear that has gripped investors worldwide, and in some cases entire countries, is the grim prospect for China. In a Bank of America Merrill Lynch European Fund Manager Survey, the Chinese slowdown and resultant commodity price collapse was considered as the biggest tailrisk for world economy in June 2013. The survey includes 248 global fund managers with assets under management of $708 billion.
The world’s second largest economy released its Q2 GDP numbers today which came at +7.5%, meeting expectations. But Chinese growth expectations have plunged to their lowest levels in two years, although there are still many who believe that the Chinese crisis can still be salvaged from going into full scale recession. According to Goldman Sachs, the most vulnerable sectors in China are utilities, materials, property and industrial, and the relatively safer options are software and consumer staples. Hedge funds have netted big gains from shorting equities that are either directly or indirectly exposed to China. Steel, and iron ore shorts have paid off for a number of funds, and similarly bearish calls on Australian mining industry have also done well.
Hedge Funds Riding the Short China Road
Among hedge funds, Chinese growth outlook and its ramifications has been a consistent theme. From prescient investors like Jim Chanos to newbies like Patrick Wolff of Grandmaster Capital, a doom in China has been predicted over and over again. The best bets against Chinese equities would be those that took shape when most of the market players were in denial of the dark times that laid ahead and valuations remained high. When it comes to China, the interesting thing is that while every hedge fund manager will say that China is on the road to hit rock-bottom, there are very few who have established direct shorts in the country or very few who share their portfolio exposure.
Hedge Fund Riders: Jim Chanos, Hugh Hendry, Patrick Wolff
Jim Chanos, a long term China bear and one of the most prescient shortsellers of our time, has been predicting the collapse of China’s all major industries for the last two years now. Chanos is known to hold long term positions and if he got in his shorts a couple of years ago, he is likely sitting on quite a lareg amount of returns. Chanos had forecasted a slowdown in Chinese home sales, and he has maintained short exposure in China both directly and indirectly. Chanos is short on metals and mining companies, which derive their revenue from China and he has also been bearish on Chinese construction companies and banking sector.
Another consistent China shortseller has been Hugh Hendry, whose fund has maintained short exposure in China versus long in USD and U.S. equities for quite a while now. In May, Hendry’s Eclectica Fund added to its shorts in China as the credit crisis gained more steam. Eclectica is also bearish on emerging market currencies and Australian rates.
A lesser known and upcoming hedge fund manager, Peter Wolff, actively began shorting Chinese companies when he started his own fund, Grandmaster Capital. Wolff has lamented the massive corruption and mis-allocation of capital in the country. A few weeks ago he again pointed out how interbank lending rates had reached record highs and are burning everybody who is involved. Grandmaster Capital is short Chinese companies and long U.S. equities. Wolff has said that the world pays far too much attention to whether or not the Fed will taper or not taper, and he feels the more critical issue is how a crash is waiting to happen in China.
Stanley Druckenmiller on China
There are others like Stanley Druckenmiller and Marc Faber who have expressed their less than favorable view of Chinese economy and regulations. Druckenmiller has pointed out aging demographics, and unbalanced capacity vs. demand situation as major concerns in China. He believes China will rebalance and investment will slow down. Druckenmiller has indirect short exposure in China, and he has recommended shorting AUD and other commodity related currencies and equities which are dependent on China.
Most recently, Kyle Bass trained his bear guns on China after doing the same to Japan. Bass thinks that China’s banking sector has expanded to unsustainable levels, as the country has a credit system approximately worth 256% of total GDP. On a comparative scale, China’s annualized credit expansion has been three times of what the U.S. experienced at the peak of the bubble in 2006. Bass believes that if China acts quickly and puts a stop to the uncontrolled credit boom and settles with a period of lower growth, it could rid itself of a much worse fate.
Tiger cub Andreas Halvorsen has also stepped up his scrutiny of China, reports Stephen Taub of II Alpha. Halvorsen’s hedge fund, Viking Global, communicated to investors that it was studying how Chinese slowdown will affect the global markets. Halvorsen is convinced that other than China’s effect on metals and mining, Aussie dollar and volatile fudning rates, there are unexplored avenues where China will have negative impact. The fund said in its quarterly letter that its latest analysis has led upto paring back of some long positions while adding to short exposure, however it is unclear whether Viking has any direct short in China. Viking Global Long Fund was up 12.6% in H1, netting only 2.3% in Q2. Viking Global Equities’s long/short equity fund took in a gain of 7.2% in the first half.
More China Shorts as Crisis Worsens
Indications of who has outright shorts in China are just as murky as Chinese markets are. China has been accused of running one of the most unregulated markets with non-existent transparency levels. It appears that investors have either remained unconcerned about China or are fearsome that bearish calls will not play out in a market where corruption is so widely propagated. Most of the funds either have very little short exposure or none at all which is odd considering how crucial Chinese economy is to the global growth. Nonetheless, we suspect more hedge fund managers to jump in on the China short channel over the next few months—however the best and most profitable bets were those placed when the crisis was in infancy stages.