Carlyle's ESG, Passport Cash In on China Bets as Yuan Plummets

  • Hedge fund manager says currency could fall by 30% in 2016
  • Burbank's special opportunities fund returned 17.6% last year

For Emerging Sovereign Group’s Brian McCarthy, the decline in the Chinese yuanarrived right on schedule.

In an Oct. 8 conference call with investors, McCarthy predicted that China would allow the yuan’s drop against the dollar to accelerate after the International Monetary Fund designated the yuan a global reserve currency. On Nov. 30, in a nod to China’s global economic might, the IMF’s Executive Board gave the yuan the global status that the country’s leaders sought.

McCarthy, who leads ESG’s Nexus strategy, was positioned to cash in as the People’s Bank of China acted as he expected. The approximately $500 million fund, which is devoted to a bet that the Chinese economy will deteriorate, gained 16.5 percent in December, according to a person with knowledge of the fund’s returns. ESG, which is majority-owned by Carlyle Group, joined the likes of hedge funds Passport Capital, Omni Partners and Odey Asset Management in making money by betting against China’s economy.

The yuan tumbled to its lowest in five years on Jan. 7, sending shock waves through financial markets worldwide and escalating fears of a global currency war. The PBOC had set its reference rate for the currency at an unexpectedly weak level, a signal that it’s more tolerant of the yuan’s depreciation as China’s economy is estimated to grow at the slowest pace in 25 years.

While a weaker yuan supports China’s export sector, it also boosts risks for the nation’s foreign-currency borrowers and heightens speculation that the slowdown in Asia’s biggest economy is deeper than official data suggest. The currency has declined 5.98 percent against the dollar in the past year.

“They are not willing to let it go too far,” John Burbank, founder of $4.4 billion Passport Capital, said in a Jan. 8 interview. “They’ve never had to do this. If they let it slide 5 to 10 percent in January, there will be no market that’s up anywhere in the world. They can’t curtail money going out of the country. A 15 percent drop in the currency could be the equivalent of what happened to markets after September 11th."

Options Bet

Passport’s special opportunities fund rose 5.4 percent in December, according to a person with knowledge of the returns, bringing 2015 gains to 17.6 percent. Passport’s main fund gained 8.4 percent last year.

On the Oct. 8 call, ESG’s McCarthy, who works closely with ESG partner Mete Tuncel, compared bets against China to wagers against the subprime housing market in 2008. He said it was cheap to purchase options that the yuan could fall.

Sure enough, volatility in the currency picked up shortly after the IMF’s decision, particularly on Dec. 11, when China published a new index that values the yuan against a broad range of currencies.

Randall Whitestone, a Carlyle spokesman, declined to comment for this story.

Suspicious patterns in export and import data for December, which were released this week, have fanned worries that cash flowing out of the country has been masked by phony trade invoices. More than $840 billion exited China in the first 11 months of 2015, according to a Bloomberg gauge.

"Chinese officials are very concerned about speculation against the renminbi," said Robert Savage, the chief executive officer of CCTrack Solutions, a New York-based provider of foreign exchange trading strategies. "They’re very frustrated that they haven’t gotten this basket idea across," he said, referring to the new benchmark implemented last month, which is composed of 13 currencies including the dollar, euro, yen and pound.

Odey Gains 14%

ESG and Passport are not alone in predicting trouble for the world’s second-largest economy. Billionaire David Tepper, who runs hedge fund Appaloosa Management, said in November that the yuan is massively overvalued and needs to fall further. Dan Loeb told investors in his Third Point hedge fund last year that the “downside scenario for China seems more intimidating than ever before.”

Last week, the yuan’s biggest weekly loss since an Aug. 11 devaluation prompted banks including Goldman Sachs Group Inc. to cut their estimates for the currency. The options market is signaling that there’s a 33 percent chance that it will weaken beyond 7-a-dollar, data compiled by Bloomberg show.

The offshore yuan dropped 0.2 percent today to 6.62 at 11:47 a.m. in New York.

Mark Hart, whose firm handed investors a six-fold gain betting against U.S. subprime mortgages, said as early as 2011 that he was shorting the yuan through put options. In September, Hart’s Corriente Advisors raised at least $25 million for a third fund devoted to bets on China, according to a filing with the U.S. Securities and Exchange Commission. Yatrik Munshi, chief operating officer for the firm, declined to comment on the new fundraising.

Crispin Odey, founder of the $12 billion Odey Asset Management, has also been betting that China’s economic troubles could embroil the developed world. His main hedge fund jumped 14 percent in January, erasing its loss last year, as bets against China paid off. The fund rose3.7 percent in December. Odey has predicted China will devalue the yuan by at least 30 percent.

Like ‘Predator’

Omni Partners, the $965 million London hedge fund whose wagers against China helped it beat the industry last year, predicted the yuan could fall 15 percent against the dollar in 2016. Its macro fund rose 8.4 percent last year, the firm said.

Russell Clark, who runs Horseman Global Fund, is another manager who had been expecting the yuan’s devaluation. His fund jumped 20 percent last year in part from short wagers related to China’s devaluation and a subsequent market tumble.

In August, he wrote in a newsletter to investors that being bearish on China for the last few years reminded him of the 1987 movie “Predator,” in which a special forces operation is outsmarted by an alien creature who at every turn whips out special powers -- heat vision, invisibility -- that were previously unknown.

“Bearish investors in China had been picked off relentlessly and seemingly effortlessly by the government and the central bank,” wrote Clark, first by their ability to manufacture a property market and then a stock market boom. “But then just as suddenly, the stock market started to sell off and the pressure on the currency began to build.”

Clark predicted a bigger devaluation soon. His fund is up another 10.5 percent this year through Jan. 13.

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