MSCI | Wall Street conference clears air on China's hedge fund industry

Wall Street conference clears air on China’s hedge fund industry

November 10, 2015 9:36 AM (UTC+8)

 

Asia’s hedge fund industry, the state of the Chinese economy and the commodities market and the likelihood of another unexpected devaluation of the yuan were the main themes addressed by a panel of experts at the New York Hedge Fund Roundtable recently.

Shanghai Financial District
Shanghai Financial District

About 50 members of the organization committed to promoting the education and best practices of the hedge fund industry listened to Paul Smith, president and chief executive officer of the CFA Institute; Keith Black, managing director of curriculum at the CAIA Association; Kevin Chen, co-founder and chief investment officer of Three Mountain Capital Management, a global macro hedge fund; talk about the state of the Asian hedge fund industry, opportunities and challenges over the next five years and the ramifications of the volatility in China’s financial markets. Les Baquiran, president of Alpine Capital Advisors, an advisory firm that raises capital for investment managers, moderated the panel which convened in New York City last week.

There are about 8,000 hedge fund managers in China managing about $50 billion in assets, said Smith of the CFA Institute. Outside of China, there are another 1,000 hedge fund managers in Asia managing $200 billion.

“There are eight times too many of them in China,” said Smith, “and few of them are high-quality vehicles.” He said few had offshore operations and that most US managers wouldn’t be familiar with their strategies.

Smith’s organization is known for giving the test that awards financial advisors the highly-respected Certified Financial Analyst accreditation. It seats about 240,000 candidates for its exams each year, currently 100,000 of the candidates are from Asia and half of those are from China.

Smith said that people in the US have a poor understanding of China, based on their fear of a China’s rising power and what it means to the US.

“When the Chinese market has a setback, there is a tendency to amplify how important that setback is,” he said, pointing out that that the Shanghai Composite Index is only back to where it was in March. Compared to recent crashes in the US stock market this is “minor league stuff.”

He said there had been a lot of buying in anticipation that MSCI would allow mainland stocks into its emerging markets index. The MSCI decision in June to not allow mainland stocks changed sentiment dramatically, and with the government clamping down on margin buying these things fed upon each other to cause the market’s rout.

Smith said one could make the argument that there won’t be more volatility in the Chinese market because foreign hedge fund trading has been closed down and the futures market has effectively dried up after the government’s successful intervention.

“History shows that you normally have a spike then a correction,” said Smith,” then a lengthy period of sideways movement and that will most likely happen for the next six to nine months.”

The panelists all agreed that the official economic numbers coming out of the Chinese government are inflated. But countered that by saying that if anyone goes to China they will see a country that is not in recession, but clearly still growing strongly.

“China is growing no doubt,” said Smith, who has lived in Hong Kong for the past 20 years. “People are in malls. People are employed. I don’t know by how much but it’s definitely growing. China is a big complicated beast. We look at the bottom-up picture rather than the top-down, macro-economic-helicopter view.”

“I haven’t seen any signs of significant distress from the asset managers I’ve spoken to,” he said.

Chen of Three Mountain Capital Management said he doesn’t look at the government numbers, but instead at stocks in areas not controlled by the government. He said these are numbers investors can rely on, and they shouldn’t worry about the top-line economic numbers.

Chen said he sees opportunity in sectors related to ecommerce. These will give a better return perspective than companies in the mining, manufacturing and banking sectors. Because the population is aging rapidly and spending more on healthcare, there are a lot of opportunities in this sector of the economy.

Chen said the Chinese currency is the fourth currency in the world in terms of trade volume and global transactions. He said if the Chinese devalue the yuan again it would lead to many defaults in the emerging markets.

Smith said it was very unlikely that there would be another surprise devaluation. He said the last one was a panic measure that upset the Americans because it hadn’t been coordinated like other currency measures.

However, “the Chinese have been listening to what’s being said in the back channels,” he said, “if it happens again it will be done differently. It will be in a more coordinated fashion, but that won’t be anytime soon.”

“My prediction is it will continue to be tightly controlled by the state and another devaluation in the near term is highly unlikely,” said Black of the Chartered Alternative Investment Analyst Association, or CAIA

He said emerging markets around the world are experiencing weakening currencies, with many Asian currencies falling in value, much of it related to commodities.

Black said he was very concerned about capacity utilization and ghost cities. He think a lot of gross domestic product may be moving ahead of profitability or population, and drawing growth from the future.

Black said since 2000, China’s urban population has grown by 290 million people, an amount equal to 90% of the entire US population. Even as the world has geared up to supply the commodities needed to build housing for all these people, over the last 12 months the price of many energy products and industrial metals have seen their prices fall between 30% and 60%.

Black said most people think that this is a situation of weak demand, but it’s actually more about markets being over supplied. He said China has been adding significant supply in aluminum and steel.

Since the Chinese economy isn’t designed to maximize profits and make decisions based upon the economics of supply and demand, he said, it’s not reading the market cues that the market is over supplied.

Black said Chinese politicians have an accountability to increase jobs and output, but not to build a profitable company. By building cities, roads and factories, not only are they importing industrial metals, but also they’ve been adding to their domestic capacity, because low interest rates have made it easier for companies to borrow and invest more in energy and industrial metals production. This means China is moving from importer to exporter. With the domestic market oversupplied, the Chinese are now flooding the global markets with supply.

He said as China continues to grow capacity in the industrial metals market, it will be difficult to see price move significantly higher. Black said because of domestic consumption it would be easier for agricultural commodities and food products to experience higher prices than metals and energy in the near term.

Lawrence Carrel is an award-winning journalist and author of ETFs for the Long Run: What They Are, How They Work and Simple Strategies for Successful Long-Term Investing and Dividend Stocks for Dummies. His work has appeared in The Wall Street Journal, SmartMoney, TheStreet.com, Kiplinger’s Personal Finance Magazine, Reuters, The Associated Press, Investor’s Business Daily, Business Without Borders.com, The Economist Intelligence Unit, Financial Planning, Barron’s Online and others.

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