Foreign investors navigate turmoil in Chinese markets with new playbook

Bet against currencies of Asian trading partners; short HSBC Holdings and Standard Chartered Plc, who have big exposure to China

Foreign investment funds are moving at breakneck speed to retool their strategies in an attempt to profit from Chinese stock markets whipsawed by panic, paranoia and unprecedented government intervention.

The implosion in Chinese equity prices after a domestic, debt-fuelled buying binge has triggered a range of responses from foreign investors.

Those who remain bullish on China's long-run economic prospects have switched more of their focus to the Hong Kong market because valuations are lower, it is better regulated, and less prone to the whims of officials in Beijing than the mainland markets in Shanghai and Shenzhen.

Funds that see the recent declines in the yuan, Chinese asset prices, and the nation's exports as a harbinger of much more economic pain to come are responding with an array of manoeuvres. Those include betting against the currencies of Asian trading partners, and shorting British banks HSBC Holdings Plc and Standard Chartered Plc , who both have big exposure to China.

 

Some are even buying US mortgage-backed bonds on the expectation that rich Chinese will take money out of China and pour it into US real estate as a safe haven.

The investors who are betting against China or have given up on it as an investment destination are in the minority, though.

Despite all the problems, the Chinese economy is still expected to grow at around 7% this year, based on official figures. That can't be sniffed at given the downturns in many other major economies, such as Brazil, Russia and Canada, and only modest growth in the US and Europe.

That doesn't mean many believe it is safe to trade the mainland markets, where the Chinese authorities have cracked down on short selling, detained a journalist for spreading false information and re-routed pension money into equities.

"The recent volatility I think has cooled the ardour of some because they are realising what an unusual instrument the Shanghai Stock Exchange is," said William Kirby, a Harvard Business School professor who studies China and is involved with several funds that invest in the country, including as a director of the $248 million China Fund Inc .

"It appears this (Chinese) administration sees stock markets as instruments of state policy," he said, adding that his comments reflected only his personal views.

The safer alternative is seen as Hong Kong. The Hang Seng Index, the mainstream index for the territory's market, has dropped 24.3% over the past three months, compared to a 36% slide for the Shanghai SE Composite Index and a 45% fall in the Shenzhen SE A Share Index.

A NEW UNIVERSE

BlackRock Inc , the world's largest asset manager, is snapping up shares of Chinese companies listed on the Hong Kong exchange after the recent declines, said Jeff Shen, head of emerging markets for BlackRock. "We think it's a value play."

Bobby Bao, who runs the $1.3 billion China Region Fund for Boston-based Fidelity Investments, is still hunting for value in the mainland markets, though only in certain high-growth sectors. He is particularly interested in investments that will capitalise on China's demand for personal concierge services, ranging from make-up application at home to car washing and in-house catering.

In recent months, he has bolstered his stake in Hangzhou Hikvision Digital Technology Co Ltd, the world's largest maker of surveillance cameras that's listed on the Shenzhen Stock Exchange. He cited the company's 40% compound annual growth rate and the rapid expansion in the installed base of security cameras.

In July, though, the company called off its planned $1 billion initial public offering on the Hong Kong exchange because the territory's H-shares trade at much lower valuations than mainland A-shares. The valuation gap is one of the reasons foreigners have not been big investors in mainland-listed companies, even before the recent plunge.

Indeed, overseas funds are estimated to hold only about 1% of the $7.8 trillion total valuation of all stocks traded on mainland China's markets, according to Zhiwu Chen, a finance professor at Yale University's school of management.

For those fund managers wanting to tap into Chinese consumer demand, some e-commerce companies are still attractive.

"The Chinese love to buy things online and this sector has a lot of upside," said Joe Quinlan, chief market strategist at Bank of America wealth management unit US Trust.

SHORT BETS

With Chinese authorities cracking down on what they call "malicious" short sellers, foreign investors are steering clear of any short strategies on mainland markets.

For those that want to take a bearish punt on China there are other, less controversial avenues.

Tracy Chen, portfolio manager of the $935 million Legg Mason Brandywine Alternative Credit fund , said China's slowing economy prompted her last month to short the currencies of a number of its Asian trading partners, expecting they will decline as they take steps, such as cutting interest rates, to stimulate their own economies.

Her fund has also made short bets on HSBC and Standard Chartered plc because of their big presence in the Greater China region.

Andrew Lee, deputy head of the ultra-high net worth and alternative investment office at UBS Wealth Management in New York, said that the Australian dollar > also is being shorted by some hedge fund managers. The currency has been falling, partly because of slack Chinese demand for Australian metals and minerals.

The Canadian dollar > is also being targeted by some investors for similar reasons, said Eric Stein, co-director of the global income group at Boston-based fund firm Eaton Vance.

One safe-haven strategy that hasn't performed as well as in the past is buying US Treasuries.

"They haven't done so well in the last month or so," Stein said. Some investors speculate that the Chinese government has been selling US Treasuries and buying yuan to keep the currency from selling off.

Chen, meanwhile, said she has been buying more mortgage-backed bonds as she expects wealthy Chinese investors, who have already been active in North American real estate markets in recent years, to step up their purchases another notch as a hedge against further trouble in China.