Hedge funds clamor for China shares despite curbs http://www.reuters.com/article/reutersEdge/idUSPEK16495620070327
Tue Mar 27, 2007
By Jeffrey Hodgson and Brian Kelleher - Analysis
HONG KONG (Reuters) - Hedge funds are hungry for a bigger bite of China's booming but restrictive stock market, undeterred by last month's gut-wrenching one-day selloff and limitations on their access and trading strategies.
Mainland shares soared 130 percent last year, reversing a five-year losing streak and drawing global investor attention. But Beijing has only granted Qualified Foreign Institutional Investor (QFII) quotas of $10 billion, mostly to major banks, which can make that quota available to money managers.
Hedge funds, which aim to generate returns in both bull and bear markets, are putting pressure on their prime brokers to get them more access to mainland-listed A-shares, as they see both near-term trading opportunities and long-term prospects.
China's ban on short-selling -- a practice typically used by hedge funds to make bets on shares falling -- has not prevented foreign managers from investing in A-shares.
"Would I like to invest more in China A-shares via QFII? Absolutely," said George Long, chairman and chief investment officer of Hong Kong-based hedge fund manager LIM Advisors.
"That said, the easy money has been made. Are there opportunities still? Absolutely."
Long's firm manages $820 million in assets, including about $25 million invested in A-shares.
China's benchmark Shanghai composite index (.SSEC: Quote, Profile, Research) spent much of early 2007 setting new record highs until a nearly 9 percent plunge on February 27 that helped trigger a global market slide.
BLACK TUESDAY'S BRIGHT SIDE
While the plunge spurred many investors to sell, it proved a boon for more risk-tolerant hedge funds who bought on the dip as the market has shot back to fresh highs.
"After the 27th of February, the Black Tuesday, we got a lot of recycling of the QFII, which I am very happy to receive," said Yang Liu, managing director with Atlantis Investment Management.
"From that day until today we made a 20 percent return already," she added, noting that gaining access to QFII quota held by banks had once again become difficult.
Chinese officials have indicated the total QFII ceiling quota will eventually be raised again but have given no clear indication of the timing or size of the increase. The existing $10 billion quota has been almost entirely allocated.
Liu would like to double the A-share exposure of her $450 million Atlantis China Fortune hedge fund to 10 percent, saying currency appreciation, strong earnings growth and a rerating of Chinese stocks to carry a higher premium should all fuel gains.
"The earlier you invest in this country, the bigger return you will get in 2 to 3 years' time," she said.
Fund managers and prime brokers, who service hedge fund clients, said QFII demand marked a major shift from two to three years ago, when the Chinese market was in the doldrums.
"We continue to see strong interest in China, although demand has calmed down a bit recently", said Tim Wannenmacher, head of Asia capital markets prime services for Lehman Brothers
(LEH.N: Quote, Profile, Research).
Prior to the February 27 drop, Merrill Lynch (MER.N: Quote, Profile, Research) was getting five to 10 requests per day from hedge funds looking for additional QFII access, with Harvey Twomey, head of Pacific Rim sales for the bank's global markets financing & services team, calling their appetite "voracious."
Some major hedge fund managers have even applied or are in the process of applying directly for QFII quota, said Mark Shipman, a partner with Hong Kong law firm Clifford Chance.
"My view is that China will at some point want to allow one or two hedge funds through some sort of pilot program, just to see how they behave and try to use that as a way to better understand hedge funds," he said.
SHORT BAN
Hedge funds are buying into the market even though they are forbidden from using one of their favorite tools: short selling. This allows them to borrow stock and sell it, hoping it will fall in value so they can buy it back cheaper and book a profit.
Managers are trying offset the A-share shorting ban by shorting the shares of Chinese companies listed in Hong Kong, or the China Enterprises index of H-shares (.HSCE: Quote, Profile, Research) and the iShares FTSE/Xinhua A50 China Tracker (2823.HK: Quote, Profile, Research) fund.
But Lim's Long said the ability to short A-shares is not the key consideration for many managers.
"If you're a serious investor, you would want to have some participation if for no other reason than to learn from the market," he said. "There is no question China will become a major capital market."
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